The foundation: one income statement feeds nine of the ten
Before any method works, you have to rebuild the property's income statement the way an appraiser would — not the way the listing broker presented it. Nine of the ten methods take a number straight off this ladder. Get the ladder wrong and every method downstream is wrong in the same direction.
The income ladder
The line above NOI is the property. The line below NOI is your deal. Two buyers analysing the same building share every number down to NOI and share nothing after it.
The four terms people get wrong
Potential Gross Income is what the property would produce at 100% occupancy at market rent, plus all other income — pylon signage, parking, laundry, roof antenna licences, percentage rent. Not what the current leases happen to say if those leases are below or above market. A vacant unit still contributes its market rent to PGI; the vacancy allowance is what takes it back out.
Vacancy and bad debt allowance is a forward-looking, market-derived percentage — not last year's actual vacancy. A building 100% leased today still carries an allowance, because leases roll. Applied to PGI, never to NOI.
Operating expenses are the costs of running the property, and appraisal practice includes a reserve for replacement — an annual set-aside for roof, HVAC, and paving, which never appears on a vendor's actual statement. Four things are categorically excluded:
- Mortgage payments (principal or interest) — that is financing, and financing is specific to the buyer, not the property.
- Income tax — specific to the owner. Realty taxes are an operating expense; income tax is not.
- Capital expenditures — a new roof is capital; the annual reserve for it is the operating expense.
- Depreciation (book) — an accounting entry, not a cash cost of operating.
Leave any of these in and you understate NOI, which understates value at every cap rate you apply.
Net Operating Income is income before financing and before income tax. It is the single most important number in commercial real estate, because it is the numerator or denominator of five of the ten methods below.
The classic wrong answer subtracts mortgage payments to get NOI. It doesn't. NOI is unlevered — the same for an all-cash buyer and a 75%-leveraged buyer. If a question gives you a mortgage payment and asks for NOI, the mortgage payment is a distractor.
Net leases vs. gross leases change where the expenses sit, not whether they exist. Under a triple-net structure the tenant pays realty tax, insurance and maintenance directly, so both PGI and OpEx are smaller — but NOI lands in roughly the same place. Never compare a gross-lease GIM to a net-lease GIM.
The case file: Maple Row Plaza
Every worked example below uses this one property. Keep it open in a second tab while you study — the point of the course is watching the same building return ten different verdicts.
Maple Row Plaza — Mississauga
The buyer's financing assumption
Three comparable sales, last nine months
| Comparable | GLA | Price | $/sf | Cap | GIM |
|---|---|---|---|---|---|
| A · Brampton | 9,800 sf | $2,950,000 | $301 | 6.60% | 9.1 |
| B · Mississauga | 14,500 sf | $4,640,000 | $320 | 6.30% | 9.5 |
| C · Oakville | 11,200 sf | $3,304,000 | $295 | 6.70% | 8.9 |
| Indicated range | — | — | $295–320 | 6.5% | 8.9–9.5 |
Direct comparison — price per unit of comparison
AnswersWhat are buyers actually paying for a square foot of this kind of space in this market, right now?
The oldest and bluntest method: reduce every comparable sale to a common denominator, then apply that denominator to the subject. For retail and industrial the unit is the square foot of gross leasable area. For apartments it is the suite. For land it is the acre, the front foot, or the buildable square foot. For hotels, the key; for self-storage, the locker.
Adjust each comparable for time of sale, location, size, age/condition, and lease structure before averaging — never average raw.
Worked on Maple Row
Read: the asking price is $350/sf against a comp range that tops out at $320. On this method alone the vendor is roughly 9–15% above market. That is a sighting shot, not a conclusion — but it is the number you can defend to a client in one sentence.
Price per square foot says nothing about income. A 12,000 sf plaza at $305/sf with three vacant units and a 12,000 sf plaza at $305/sf fully leased to national covenants are not the same asset. Use this method to bracket, never to conclude — and never on a property whose income profile is unusual for its class.
The cost approach
AnswersWhat would it cost to replace this building today, and what has time already taken out of it?
Value equals the land as if vacant, plus the depreciated cost of the improvements. It sets a rational ceiling: no informed buyer pays more for an existing building than the cost of buying land and building a new one — allowing for the time and risk of doing so.
Accrued depreciation has three sources: physical deterioration (wear), functional obsolescence (bad design), and external/economic obsolescence (the neighbourhood or the market).
Worked on Maple Row
Read: $3.61M, tightly bracketing the comparison method's $3.66M. When cost and comparison land within 2% of each other, you have a credible floor–ceiling band before you have looked at a single dollar of rent.
Two distinctions get tested. Reproduction cost duplicates the building exactly, including its obsolete features; replacement cost builds an equivalent with modern materials and already excludes some functional obsolescence — don't deduct it twice. And land is never depreciated: depreciation applies only to improvements.
The cost approach is weakest exactly where investors buy: older, income-producing property where depreciation is large and subjective. It is strongest on new construction, special-purpose buildings, and insurance valuations. Weight it accordingly.
Gross Income Multiplier
AnswersHow many years of gross rent is the market paying for a building like this?
The fastest income-based screen there is. Divide a comparable's sale price by its gross income; apply the resulting multiplier to the subject's gross income. It ignores operating expenses entirely — which is both why it takes ten seconds and why it is dangerous.
Be explicit about which income you used. A GIM built on PGI and applied to EGI understates value by exactly the vacancy rate.
Worked on Maple Row
Read: $3.68M — a third independent method inside the same $3.6–3.7M band. Meanwhile the asking price implies a GIM of 10.5 against a market that is transacting between 8.9 and 9.5. Three methods now say the same thing.
GIM is only valid between properties with similar expense ratios. A plaza where the landlord pays all utilities and a plaza on triple-net leases can trade at identical cap rates and wildly different GIMs. If the expense ratios differ by more than a few points, the multiplier is comparing two different things.
Higher GIM means more expensive, and higher cap rate means cheaper. They run in opposite directions. Students reliably reverse one of them under time pressure.
Net Income Multiplier
AnswersHow many years of net operating income does this price represent?
The same idea as GIM but built on NOI, which means it does account for operating expenses. It is the arithmetic reciprocal of the capitalization rate — the same fact stated as a multiple rather than a yield.
Worked on Maple Row
Read: the vendor is asking for 17.5 years of net income in a market paying 15.4. Some clients hear "17.5 years to get your money back" more clearly than they hear "5.71% cap rate." Same sentence, different listener.
NIM is not a payback period. It ignores financing, income growth, and the sale proceeds at the end. Use it as a translation of the cap rate for a client who thinks in years, not as a return measure.
Direct capitalization — the cap rate and IRV
AnswersWhat is this property worth, given what the market is currently willing to earn on comparable income?
The centre of gravity of commercial valuation. One year of stabilized net operating income, divided by a rate the market tells you, produces a value. Everything else on this page is either an input to it or a cross-check on it.
The IRV triangle: cover the letter you want and the remaining two show you the operation. I over R gives Value; I over V gives Rate; R beside V gives Income.
Worked on Maple Row
Why the rate moves
A cap rate is a price for risk. It rises — and value falls — with weaker tenant covenants, shorter remaining lease terms, secondary locations, older buildings, and higher interest rates. It falls with national credit tenants, long leases with fixed escalations, urban infill sites, and cheap debt. Every 25 basis points on Maple Row is worth roughly $140,000 of value, which is why the rate you select needs a paper trail.
Read: $3,692,300 — call it $3.69M. This is the number that carries the most weight for an income-producing asset, and it is the one your offer will be built on.
A cap rate is extracted from the market, never chosen because it feels right and never set equal to the mortgage rate. If a question gives you comparable sales, the cap rate is hiding in them — derive it. Choosing one arbitrarily is the single most common way to get a valuation question wrong.
Direct capitalization uses one year of stabilized NOI. If the subject has a vacant unit about to be leased, a rent-free period running, or an above-market legacy lease expiring next year, capitalizing the in-place number gives a false answer. Stabilize first, then capitalize — or move to discounted cash flow (method 10), which is built for exactly that situation.
Band of investment — building the cap rate
AnswersWhen there are no clean comparable sales, what cap rate does the capital market itself imply?
A property is bought with two kinds of money — the lender's and the investor's — and each demands its own return. Weight those two returns by their share of the purchase price and you have constructed a cap rate from first principles. It is the appraiser's fallback when sales evidence is thin, and the sanity check when it isn't.
The mortgage constant is not the interest rate. It includes principal repayment, so it is always higher than the rate — and the gap widens as amortization shortens.
Worked on Maple Row
Read: 6.48% built from the money side, against 6.50% extracted from three sales. The two agree, which means the comparable sales are behaving rationally and the 6.50% you are about to apply has independent support. When these two disagree by more than about 50 basis points, one of them is telling you something — usually that the comps involved a motivated party or an off-market rent assumption.
Using the interest rate instead of the mortgage constant. At 5.75% over 25 years the constant is 7.55% — a 180-basis-point difference that flows straight into the answer. Compute the annual payment, divide by the loan, and use that.
Cash-on-cash return · equity dividend rate
AnswersWhat percentage does the buyer's own money earn in cash in year one?
The first method on this page that is about the investor rather than the property. Cap rate measures the building unlevered; cash-on-cash measures what actually lands in the buyer's account after the lender is paid, divided by the cash they put in. Most private investors care about this number more than any other.
"Initial cash invested" is the down payment plus closing costs, land transfer tax, due diligence and any immediate capital — not the down payment alone.
Worked on Maple Row, at the supported value of $3,690,000
The leverage test — and the number most people miss
Compare the cap rate to the mortgage constant, not to the interest rate:
Because the constant exceeds the cap rate, borrowing pulls the cash return down — from 6.50% unlevered to 4.56% levered. That is not automatically a bad deal, because the principal portion of every payment is the buyer's money moving from one pocket to another:
Read: 4.56% in cash, 8.00% including forced equity build-up. A client who only hears "4.56%" will walk away from a deal that is actually returning 8% before a dollar of appreciation. Presenting both numbers is the job.
Cash-on-cash ignores three of the four ways real estate pays: principal paydown, appreciation, and tax shelter. It is a year-one snapshot of one of them. Never present it as "the return."
The test for positive leverage is cap rate vs. mortgage constant. Cap 6.50% against an interest rate of 5.75% looks positive and isn't. Amortization is what closes that gap.
Debt service coverage — the lender's three tests
AnswersWill a lender actually finance this, and at what size of loan?
A deal that pencils for the buyer and fails at the lender is not a deal. Underwriters apply three tests and lend on the smallest of the three results. Running them yourself before you write the offer is what separates a conditional financing clause that clears from one that dies on day 25.
Debt yield is the one that ignores both the rate and the amortization, which is why lenders lean on it hardest when rates are volatile.
Worked at the supported value of $3,690,000
The same tests at the $4,200,000 asking price
Read: at the asking price the deal fails the coverage test outright. The lender caps the loan at $2.54M, so the buyer must find $1.66M in cash instead of $1.29M — $367,000 more equity for an asset that produces the same $240,000. This is the argument that moves vendors: the price isn't just above market, it's above what the market will finance.
DSCR uses NOI over annual debt service — not cash flow after debt, and not EGI. A ratio below 1.00 means the property cannot pay its own mortgage from operations.
Lenders apply LTV to the appraised value or the purchase price, whichever is lower. An over-paying buyer does not get a bigger loan. And they underwrite their own NOI — expect them to strip out optimistic other income and apply a stiffer vacancy allowance than the listing did.
Operating expense ratio & break-even ratio
AnswersIs this building run efficiently, and how far can income fall before it stops paying for itself?
Two risk ratios rather than value methods. Neither produces a price; both tell you whether the price you calculated is safe. The operating expense ratio benchmarks efficiency against the class; the break-even ratio — also called the default ratio — measures the cushion between operating reality and a missed mortgage payment.
Break-even is the occupancy level at which the property exactly covers operations and debt. Everything above that line is cash flow; everything below it comes out of the owner's pocket.
Worked on Maple Row
Read: the plaza breaks even at 80.3% occupancy, so it tolerates just under 20% vacancy before the owner funds the mortgage personally. With six units, that is one full unit of cushion plus a little — thin enough that the covenant quality of the two largest tenants is now the most important question in the due diligence.
Note the denominators: expense ratio is over EGI, break-even is over PGI. Swapping them is a standard distractor. An unusually low expense ratio is a warning, not a win — it usually means deferred maintenance, no management fee, or no replacement reserve in the statement.
Discounted cash flow — NPV and IRR
AnswersGiven everything that happens over the whole hold — growing rents, amortizing debt, and a sale at the end — what return does this actually deliver?
Direct capitalization freezes one year. Yield capitalization models every year of the hold plus the reversion, then discounts them back. It is the only method on this page that handles a property whose income is changing: lease-up, staged rent steps, a repositioning, a below-market lease rolling to market.
The reversion is capitalized on the following year's NOI — a buyer at the end of year 5 is purchasing year 6's income.
Worked on Maple Row — 5-year hold, equity $1,290,000
| Year | NOI | Debt service | CFBT |
|---|---|---|---|
| 1 | $240,000 | $181,170 | $58,830 |
| 2 | $246,000 | $181,170 | $64,830 |
| 3 | $252,150 | $181,170 | $70,980 |
| 4 | $258,454 | $181,170 | $77,284 |
| 5 | $264,915 | $181,170 | $83,745 |
Reading NPV and IRR together
- NPV positive → the deal beats the investor's required return. Its size is the surplus in today's dollars. Here, $62,700 of margin at a $1.29M equity cheque — real, but thin.
- NPV = 0 → the deal exactly meets the requirement. At a 10% discount rate the maximum justified equity is $1,352,700, which is where the price ceiling comes from.
- IRR 11.1% vs. required 10% → the same verdict expressed as a rate. IRR is comparable across deals of different sizes; NPV tells you how much money the margin is worth.
Read: 11.1% IRR from a 6.5% cap asset. The gap is the whole argument for leveraged real estate — rent growth, amortization and the reversion do the work that year-one cash flow doesn't. But notice the fragility: move the exit cap from 6.75% to 7.25% and the IRR falls under 9%, turning NPV negative. In a DCF, the exit assumption usually matters more than anything in years 1 through 4.
The discount rate and the cap rate are different animals. The cap rate converts one year of income to value; the discount rate is the investor's required yield over the whole hold. In a growing market the discount rate exceeds the cap rate by roughly the growth rate.
The exit cap is normally set at or above the going-in cap — the building is five years older at sale. An exit cap below the entry cap is an assumption you must justify explicitly, and it is where optimistic pro formas hide.
IRR assumes interim cash flows are reinvested at the IRR itself, which overstates returns on high-IRR deals. It also breaks down when cash flows change sign more than once. When a pro forma shows an implausible IRR, look for a negative year mid-hold.
Reconciling ten answers into one number
The methods are not a menu. They are a sequence, and their disagreements are information. Here is what Maple Row produced.
| Method | Indication | Weight |
|---|---|---|
| 01 · Direct comparison | $3,660,000 | Supporting |
| 02 · Cost approach | $3,610,000 | Ceiling test |
| 03 · Gross income multiplier | $3,680,000 | Screen |
| 04 · Net income multiplier | $3,691,200 | Restatement of 05 |
| 05 · Direct capitalization | $3,692,300 | Primary |
| 06 · Band of investment | Confirms 6.48% | Rate support |
| 07 · Cash-on-cash | 4.56% / 8.00% total | Buyer test |
| 08 · DSCR & lender tests | 1.32 — passes | Feasibility gate |
| 09 · Break-even ratio | 80.3% | Risk gate |
| 10 · Discounted cash flow | 11.1% IRR · NPV +$62,700 | Confirming |
The reconciliation
Six independent methods cluster between $3.61M and $3.69M. Direct capitalization carries the most weight because this is a stabilized, income-producing, multi-tenant asset in a market with credible comparable sales — exactly the conditions the method was built for. The cost approach sets a defensible ceiling, and the two multipliers agree without adding independent evidence.
Concluded market value: $3,675,000 — approximately $306 per square foot, a 6.53% cap rate, and 12.5% below the $4,200,000 asking price.
What that means at the negotiating table
- Open at $3,450,000 — roughly 6.96% cap, defensible because it sits inside the comp range on a $/sf basis and leaves negotiating room.
- Ceiling at $3,700,000 — above this the DCF's NPV turns negative against the client's 10% requirement, and the story stops being arithmetic and starts being hope.
- Lead with the lender, not the appraisal — "your price doesn't finance at 1.25 coverage" is harder for a vendor to argue with than "my cap rate is different from yours."
- Condition on covenant review — an 80.3% break-even with six tenants makes the top two leases the real asset. Get the leases, the estoppels, and the tenant financials.
Which method to trust when they disagree
- Stabilized income property with good comps → direct capitalization, confirmed by comparison.
- Income changing over the hold — lease-up, repositioning, staged steps → discounted cash flow.
- New, special-purpose, or no comparable sales → cost approach.
- Thin sales evidence but an active debt market → band of investment to build the rate.
- Owner-occupier buying for their own business → comparison and cost lead; the income methods measure an opportunity cost, not their actual return.
- Land, or a building worth less than the site → comparison on a per-acre or per-buildable-foot basis, and test whether demolition is the highest and best use.
Formula sheet
Everything on one screen. If you can reproduce this table from memory, you can sit the exam.
| Measure | Formula | Maple Row |
|---|---|---|
| Effective Gross Income | PGI − Vacancy | $380,000 |
| Net Operating Income | EGI − OpEx | $240,000 |
| Cash Flow Before Tax | NOI − ADS | $58,830 |
| Capitalization rate | NOI ÷ Value | 6.50% |
| Value | NOI ÷ Cap rate | $3,692,300 |
| Gross Income Multiplier | Price ÷ PGI | 9.2 |
| Effective GIM | Price ÷ EGI | 9.7 |
| Net Income Multiplier | Price ÷ NOI · = 1 ÷ cap | 15.38 |
| Price per square foot | Price ÷ GLA | $308 |
| Mortgage constant | ADS ÷ Loan | 7.549% |
| Band of investment | (LTV × constant) + (Eq% × EDR) | 6.48% |
| Cash-on-cash / EDR | CFBT ÷ Equity invested | 4.56% |
| Total return year 1 | (CFBT + Principal) ÷ Equity | 8.00% |
| Debt service coverage | NOI ÷ ADS | 1.32 |
| Maximum loan by DSCR | (NOI ÷ DSCR) ÷ Constant | $2,543,400 |
| Loan to value | Loan ÷ Lesser of value/price | 65.0% |
| Debt yield | NOI ÷ Loan | 10.0% |
| Operating expense ratio | OpEx ÷ EGI | 36.8% |
| Break-even ratio | (OpEx + ADS) ÷ PGI | 80.3% |
| Cost approach | Land + (RCN − Depreciation) | $3,610,000 |
| Reversion | (Yr n+1 NOI ÷ Exit cap) − Costs − Balance | $1,751,500 |
| Net Present Value | PV of cash flows − Equity | +$62,700 |
| Internal Rate of Return | Rate where NPV = 0 | 11.1% |
| Equity multiple | Total cash out ÷ Cash in | 1.63× |
Practice set
Twelve problems on a second property — a 9-unit mixed-use building. Work each on paper, then open it. Answers show the full arithmetic, not just the result.
Problem property — Alderwood Court
01Calculate effective gross income and net operating income.Solve
EGI = 560,000 × (1 − 0.06) = 560,000 × 0.94 = 526,400
NOI = 526,400 − 196,000 = 330,400
EGI $526,400 · NOI $330,400
Vacancy comes off PGI, never off NOI. The expenses come off after.
02A comparable sold for $5,200,000 with an NOI of $364,000. What cap rate did it trade at?Solve
R = I ÷ V = 364,000 ÷ 5,200,000 = 0.0700
7.00%
This is the extraction step. You do it before you value anything.
03Using a market cap rate of 6.25%, what is Alderwood worth? Is the asking price supported?Solve
V = I ÷ R = 330,400 ÷ 0.0625 = 5,286,400
Asking 4,400,000 → implied cap = 330,400 ÷ 4,400,000 = 7.51%
$5,286,400 — the asking price is well below market value
A 7.51% implied cap in a 6.25% market means one of three things: the income is overstated, there's a problem you haven't found, or it's genuinely mispriced. Verify the rent roll before you celebrate.
04A comparable sold for $3,150,000 on PGI of $350,000. Apply its GIM to Alderwood.Solve
GIM = 3,150,000 ÷ 350,000 = 9.0
Value = 9.0 × 560,000 = 5,040,000
GIM 9.0 · Indicated value $5,040,000
Lower than the cap-rate answer, which tells you Alderwood's expense ratio is lighter than the comparable's. Worth checking why.
05At the asking price with 70% financing and a 7.5% mortgage constant, what is the DSCR?Solve
Loan = 4,400,000 × 0.70 = 3,080,000
ADS = 3,080,000 × 0.075 = 231,000
DSCR = 330,400 ÷ 231,000 = 1.430
1.43 — comfortably above a 1.25 requirement
06The lender requires 1.25 coverage. What is the maximum loan, and what LTV does that represent at the asking price?Solve
Max ADS = 330,400 ÷ 1.25 = 264,320
Max loan = 264,320 ÷ 0.075 = 3,524,267
LTV = 3,524,267 ÷ 4,400,000 = 80.1%
$3,524,267 — but capped by the 70% LTV test at $3,080,000
Run all three tests and lend on the smallest. Here LTV binds, not coverage.
07Calculate the cash-on-cash return at the asking price with the 70% loan.Solve
Equity = 4,400,000 − 3,080,000 = 1,320,000
CFBT = 330,400 − 231,000 = 99,400
CoC = 99,400 ÷ 1,320,000 = 0.0753
7.53%
Compare: cap rate at asking is 7.51%, mortgage constant is 7.50%. Constant just below cap = leverage is essentially neutral, which is why the two returns are nearly identical.
08Calculate the break-even ratio at the asking price.Solve
(196,000 + 231,000) ÷ 560,000 = 427,000 ÷ 560,000 = 0.7625
76.3% occupancy to break even
Roughly 24% vacancy cushion — better than Maple Row's 20%.
09Build a cap rate: 70% LTV, 7.5% mortgage constant, investor requires a 6% equity dividend rate.Solve
Debt band = 0.70 × 0.075 = 0.0525
Equity band = 0.30 × 0.060 = 0.0180
Cap rate = 0.0525 + 0.0180 = 0.0705
7.05%
Against a 6.25% market cap this says the debt market wants more than sales evidence implies — a sign that recent comps may pre-date the current rate environment.
10Calculate Alderwood's operating expense ratio and price per square foot at the asking price.Solve
OER = 196,000 ÷ 526,400 = 0.3723
$/sf = 4,400,000 ÷ 16,000 = 275
37.2% · $275 per square foot
11Year 6 NOI is projected at $370,000. With a 7.0% exit cap and 4% selling costs, what are the gross and net sale proceeds?Solve
Gross = 370,000 ÷ 0.07 = 5,285,714
Costs = 5,285,714 × 0.04 = 211,429
Net = 5,285,714 − 211,429 = 5,074,285
Gross $5,285,714 · Net of costs $5,074,285
Subtract the outstanding mortgage balance next to reach the equity reversion.
12The seller's statement shows $150,000 of expenses, including a $22,000 mortgage interest line, no management fee, and no reserve. Reconstruct it, and state the value impact at a 6.25% cap.Solve
Stated expenses 150,000
Remove mortgage interest −22,000
Add management @ 4% EGI +21,056
Add reserve @ $3/sf +48,000
Reconstructed expenses 197,056
Reconstructed NOI = 526,400 − 197,056 = 329,344
Value = 329,344 ÷ 0.0625 = 5,269,504
Seller's NOI = 526,400 − 150,000 = 376,400
Seller's value = 376,400 ÷ 0.0625 = 6,022,400
Reconstruction removes $752,896 of claimed value
This is the single most valuable thing you do for a buyer client. Three ordinary adjustments — one improper inclusion, two proper omissions — move the answer by three quarters of a million dollars. Never capitalize a vendor's NOI.
The exam traps, collected
Every flagged item above, in one list. Most failed questions are one of these.
- Mortgage payments are never an operating expense. Neither is income tax, capital expenditure, or book depreciation. Realty tax is.
- Vacancy applies to PGI, not NOI. And it is a market-derived forward allowance, not last year's actual.
- A reserve for replacement is an operating expense in appraisal practice, even though it never appears on a vendor's statement.
- Cap rates are extracted from the market, never invented and never set to the mortgage rate.
- Cap rate and value move inversely. Higher cap = lower value = higher perceived risk.
- GIM moves the opposite way to cap rate. Higher GIM = more expensive.
- GIM is only valid across similar expense structures. Never compare gross-lease to net-lease multipliers.
- The mortgage constant is not the interest rate. It includes principal, so it is always higher.
- Positive leverage is cap rate vs. constant, not cap rate vs. interest rate.
- DSCR uses NOI over annual debt service — not cash flow, not EGI.
- LTV applies to the lower of appraised value and price. Overpaying does not enlarge the loan.
- Expense ratio is over EGI; break-even ratio is over PGI. Different denominators.
- Direct capitalization needs stabilized income. Unstable income goes to DCF.
- The reversion capitalizes the following year's NOI, not the final year's.
- Exit cap ≥ going-in cap unless you can justify otherwise.
- Land is never depreciated. Only improvements are.
- Replacement vs. reproduction cost. Replacement already excludes some functional obsolescence — don't deduct twice.
- Cash-on-cash omits principal paydown, appreciation and tax. It is one quarter of the return.
The ten-minute deal screen
The field version. What to run, in what order, before you spend a day on a listing.
- Rebuild the NOI — strip out any financing or income tax line, add a management fee if there isn't one, add a replacement reserve, apply a market vacancy allowance. If the vendor's NOI survives this untouched, be suspicious.
- Divide by the price — implied cap rate. Hold it against the last three comparable sales you know. Off by more than 50 bps and you have a question to answer.
- Divide the price by the square footage — does it sit inside the recent $/sf range for the class and submarket?
- Test the coverage — NOI ÷ (loan × current constant). Under 1.25 and the deal needs more equity than the buyer expects, which reframes the whole conversation.
- Compute the break-even ratio — then look at the rent roll and ask which single tenant leaving would push you through it.
- Check the leverage direction — cap rate against today's mortgage constant. Negative leverage isn't fatal, but the client must hear it from you first.
- Read the lease expiry schedule — the concentration of expiries in years one through three determines whether direct capitalization is even the right method.
- Only then build the DCF — and pressure-test the exit cap before anything else in it.