The capitalization rate using the built~up technique

CFA Level II
#21

My opinion is that answer A is the most right in the context of the CFA exam.

Maybe Schweser’s question is TECHNICALLY right but that’s not what CFAI would test you on.

CFAI would focus on making you figure out a required return and then deriving a cap rate from it. If you think the answer is C, then that would mean that the building is supposed to depreciate by 2.5%. Or you think that there is no depreciation or appreciation and that the 2.5% is some other kind of risk premium.

Doesn’t matter, CFAI will not ask in this way IMHO

#22

I don’t understand the argument here. Appreciation of the real estate is a detriment to ownshership in the terms of a recapture premium (this the risk premium’s name, recapture tax will have to be paid on the real estate for its appreciation over tax depreciation that is reported). It should be added and C looks correct

#23

C is correct. My explanation was wrong.

I apologize for answering so quickly the first time. I missed that they specifically wanted “built-up” technique.

Only thing to retain after clearing this up is that the appreciation/depreciation is still excluded from this cap rate measure.

#24

Let us change the wording of the problem:

Assume you have determined that a real estate investment will have a NOI appreciation of 2.5% per year** , has a 2% liquidity premium, and **** has a 1% risk premium. Further, assume that the prevailing rate on government **** bonds, net of real estate **** tax **** savings, is 5.25%. The capitalization rate using the built~up technique is closest to:**

A. 5.75%.

B. 10.00%.

c. 10.75%.

#25

Dreary, be careful you might screw others up by going on this tangent…

#26

Straightkacket, this is how CFAI book would ask this question. The important concept here is treatment of the appreciation part. Schewser seems to ignore that…hence this is why I’m postng it.

#27

much ado about nothing. just go to the source, don’t look to AF to help you understand concepts! the answer is C. there is no “schweser way” or “cfa way”. schweser in not technically right, they are right.

#28

The answer would be "unable to solve with information provided". You need to know the appreciation adjustment to find a capitalization rate with the built-up method. I have deleted this thread from my saved list! As Jay-Z would say, on to the next one

#29

Do that buddy, but relying on Schweser alone is no good to your final score.

#30

onthegrind, don’t mislead people.

#31

funny stuff. but just go read the CFA version, then come back and tell me i’m wrong

#32

If they give you the recapture premium then use as is. If they don’t and they give you the apprecation/depreviation rate (g) of the property, then add if g < 0 and subtract if g > 0.

#33

Built up method is for the cap rate, not for R. Recapture premium is specific to real estate because you must account for the fact that properties depreciate over time - buildings lose value over time as they wear out, etc. Land is not depreciable, keep that in mind. Bonds and stocks are assets - but time doesnt cause them to lose value as real estate specifically does. Appreciation adjusted return OF investment, not ON investment.

What this is saying is that the depreciation of the property will take place faster than it’s value will grow, and I need to be compensated for that - hence, a reason why its additive. A $1mm building depreciating over 20 years depreciates at 50k per year, or 50/1mm = 5%. You could say, in the built up method, “the depreciation on the building will cost be 50k per year, but unfortunately I only expect the value to rise by 2.5% per year”. You could add the depr and then subtract the gowth rate, but the recapture premium just nets it out.

So, as CFA and Schweser both say, the answer should be C