This analysis is a review of mortgage/equity capitalization in basic terms, which can be used to test leverage, mortgage coverage, break-even point, and equity yield allocation. Mortgage/equity fundamentals show the relationship between the mortgage and equity investment rates and factors and aid in judging the reasonableness of overall rates. Is an overall rate at or below the break-even rate suspect? Is a 10% yield realistic when an annual constant is 11%? The basics provide the tools for judgement. Capitalization rates can produce high or low values depending on the mortgage and equity variables assumed as a basis for the overall rate. Components of the overall rate should be scrutinized for market reasonableness and probability. High capitalization rates associated with tax appeals should be suspect. The easiest test of a capitalization rate is cash flow (overall rate – mortgage break-even divided by equity investment/ownership percentage) based upon typical financing. The cash flow is only part of the equity yield, but it can be a red flag when analyzing overall rate acceptance. High cash flow is acceptable in high-risk properties with speculative reversion values, but it is an indication of inflated overall rate otherwise. Appraisals submitted for appeals often have tax-rate-loaded overall rates. Real estate taxes are deducted from expenses, and the overall rate is adjusted by adding an assessment factor (assessment ratio times tax rate = factor). Assessment-loaded overall rates should be adjusted back to market by deducting the assessment rate to properly evaluate mortgage/equity risks assumes. Questioning overall rates is critical, because miscalculated rates are one of the greatest causes of distorted, misleading value conclusions.
Capitalization, Discounted cash flow
Metcalf, R. L. (2015). Understanding the roots of mortgage/equity capitalization. Journal of Property Tax Assessment & Administration, 12(1), 23-31. Retrieved from https://researchexchange.iaao.org/jptaa/vol12/iss1/2