A certified general appraiser is estimating an overall capitalization rate for a newly constructed, triple-net leased industrial warehouse. The tenant has a BBB+ credit rating, the lease expires in 12 years, and market vacancy is 4%. The appraiser extracts a 6.5% cap rate from three recent sales of similar properties but adjusts upward by 0.75 percentage points to reflect the subject’s longer lease term and stronger tenant credit relative to the comparables. Which USPAP standard or advisory opinion most directly governs the defensibility of this adjustment?
Correct Answer
C) USPAP Advisory Opinion 21
Advisory Opinion 21 (AO-21), 'Capitalization Rates,' specifically addresses the development, support, and disclosure of capitalization rates — including adjustments to extracted rates based on differences in risk, lease terms, tenant quality, and property characteristics. It requires that such adjustments be supported by market evidence or logical analysis and clearly explained. Standards Rule 1-4 (data verification) and 1-2 (scope of work) are relevant broadly but do not govern rate adjustment methodology as directly as AO-21. Rule 2-2 applies to reporting, not analysis. This is an easy-to-medium item testing knowledge of the controlling authority for capitalization rate development.
Why This Is the Correct Answer
Advisory Opinion 21 (AO-21), 'Capitalization Rates,' specifically addresses the development, support, and disclosure of capitalization rates — including adjustments to extracted rates based on differences in risk, lease terms, tenant quality, and property characteristics. It requires that such adjustments be supported by market evidence or logical analysis and clearly explained. Standards Rule 1-4 (data verification) and 1-2 (scope of work) are relevant broadly but do not govern rate adjustment methodology as directly as AO-21. Rule 2-2 applies to reporting, not analysis. This is an easy-to-medium item testing knowledge of the controlling authority for capitalization rate development.
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Renewal options at below-market rent affect a leased fee valuation because:
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In a discounted cash flow analysis for a 12-year holding period, an appraiser estimates the reversion value by applying a terminal capitalization rate of 6.5% to the projected net operating income (NOI) of year 12. The year 12 NOI is $780,000. The discount rate applied to all future cash flows, including the reversion, is 8.0%. What is the present value of the reversion?