UP Standards

1.5.4.4. Direct Capitalization. Capitalization of the net operating income shall be at a rate prevailing for the type of property and location. The preferred source of an applicable capitalization rate is from actual capitalization rates reflected by comparable sales. The selection of the capitalization rate is one of the most critical factors to be applied in the income capitalization approach to value. Accordingly, developing capitalization rates from the improved sales used in the sales comparison approach provides the best market support for the rate selected for the subject property. Capitalization rates identified in national publications can be used as support for the estimated capitalization rate selected for the subject but should not be the only source for this determination.  

1.5.4.3. Expense Analysis. In developing the estimate of net operating income that will be capitalized to develop an opinion of the market value of the subject property, the appraiser must collect market data to support the estimated vacancy and credit loss, as well as operating expenses and any set asides for reserves for replacement. If available, the operating history of the subject property provides an important basis for these estimates, but data collected from other similar competitive buildings in the market area is also important to provide market support for these determinations.  

1.5.4.2. Comparable Leases. The opinion of market rent should be based on an analysis of comparable leases extracted from the market. As with the sales comparison approach, the comparable leases selected in this analysis should have the same or similar highest and best use as the subject property and reflect leases as close as possible to the effective date of value. The lease data shall be verified with a party to the transaction. It is important to identify the operating expenses paid by each party (landlord and tenant), the basis for the calculation of the leased area, and any concessions (free rent and/or tenant improvements) offered by the landlord. A physical inspection of each rent comparable is necessary to identify…

1.5.4.1. Market Rent. The income that is to be capitalized in the income approach is the market or economic rent for the subject property. These Standards use the following definition of market rental value:69 Definition of Market Rental Value  Market rental value is the rental price in cash or its equivalent that the leasehold would have brought on the date of value on the open market, at or near the location of the property acquired, assuming reasonable time to find a tenant. The appraiser should not consider the fact that a property may be under lease to a third party, except to the extent that the rent specified in the lease may be indicative of the property’s market rental value.…

1.5.4. Income Capitalization Approach. In appraising property that generates income, it may be appropriate to develop an opinion of market value using the income capitalization approach. This approach should generally be used in addition to the sales comparison approach and can serve as additional support for the final opinion of market value. In developing the income capitalization approach, it is critical that the appraiser have market support for every component such as income, expenses, capitalization, and/or discount rates.

1.5.3.1.4. Unit Rule. In developing the cost approach, appraisers must distinguish between calculating an improvement’s replacement cost and estimating market value. It is the contribution of the improvements (and all of its components) to the market value of the whole that is being measured.68 68 See Section 4.4.3.1.  

1.5.3.1.3. Entrepreneurial Profit. The estimate of the contribution of entrepreneurial profit should be supported by market data developed from properties similar to the subject improvements.  

1.5.3.1.2. Depreciation. The depreciation from all causes—including physical deterioration, functional obsolescence, and economic or external obsolescence—must be properly identified and analyzed. The estimated dollar amounts associated with each form of depreciation must be supported by market data using the breakdown method or the market extraction method. Depreciation should not be estimated by the use of published tables or age-life computations.  

1.5.3.1.1. Reproduction and Replacement Costs. The appraiser must recognize the distinction between reproduction cost and replacement cost.67 Reproduction cost is the present cost of reproducing the improvement with an exact replica; replacement cost is the present cost of replacing the improvement with one having equal utility. If the cost approach is applicable, the appraiser may use either the reproduction or replacement cost method, but must account for all forms of depreciation appropriate under the particular method chosen. In developing the cost estimate, the appraiser must account for all direct and indirect costs associated with constructing the improvements. Direct (hard) costs include the labor and materials required to construct the improvements. Indirect (soft) costs include such items as architectural and engineering…

1.5.3.1. Critical Elements. In developing an opinion of market value by the cost approach, the appraiser must recognize the critical elements that must be well supported by market evidence: reproduction and replacement costs, depreciation, and entrepreneurial profit.