Commercial Investment Real Estate September/October 2018 | Page 17

Using Caution While the cap rate valuation method is a powerful tool to evaluate a potential acquisition, prospective borrowers and lenders must employ it cautiously. There is no substitute for thorough due dili- gence, and foregoing traditional valuation can lead to significantly erroneous market value calculations, particularly in urban areas. Bryan T. Mohler is a partner in Pryor Cashman’s New York of- fice and a member of the firm’s real estate litigation and hotel + hospitality groups. Contact him at [email protected]. Build Your Own Vacation Giveaway THE CCIM FOUNDATION’S MAJOR FUNDRAISER FOR 2018 One lucky winner will receive a $5,000 voucher for a dream vacation. You choose your destination, your itinerary, and your timetable! CCIM Institute members can enter to win by donating $100 or more to the CCIM Foundation. Winners will be announced at the CCIM Fall Governance Meetings in Chicago, Oct. 7-11. You do not need to be present to win! Please contact [email protected] to get your donation form. Prize sponsored by: Your donation will be tax deductible to the extent allowed by the law. The CCIM Foundation is a 501(c)(3) nonprofit organization. CCIM.COM September | October 2018 15 laws and tax abatement schemes complicate the calculation of NOI. For example, in New York, gross rents stated on a rent roll may not reflect the actual rents paid by tenants, due to arcane rules imposed on owners of buildings subject to rent stabilization laws. The only way to verify the actual rents paid is to examine all of the individual leases and riders (where the effective monthly rent should be identified), or to examine banking records for the building. While cumbersome, this additional step is necessary to ensure that the market value calculation is reliable. The quantifiable impact of an erroneous calculation also is magnified in urban areas, where cap rates generally are lower. Since cap rates are inversely related to the market value of a prop- erty — all other things being equal, as the cap rate decreases, the market value of a given property increases — the impacts of miscalculations are compounded in areas with lower cap rates. Going back to our example, if the cap rate were doubled to 7.6 percent, the value of the building would be halved to $28,458,157.89. An inaccurate calculation of NOI also would be halved; at a 7.6 percent cap rate, if NOI were calculated erroneously as $500,000 higher than actual, it would artificially raise the value of the building by $6.5 million. Using the lower 3.8 percent cap rate more typical in urban areas, that impact would be more than $13 million. The i mi mpact are alculat f com i pou o i r ded lowe ea th r ca p ra te .