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UBC Theses and Dissertations

The use of direct conversion ratios and the selection of capitalization rates in residential income property appraisal Farish, William Gordon

Abstract

Two problems were considered in this study. The first was of selecting a capitalization rate under the traditional approach and the second was the use and accuracy of direct conversion ratios, particularly gross income multipliers. The purpose of the study was to resolve any inconsistencies and irrationalities which may exist in appraisal theory and, to the extent that direct conversion ratios are proven useful, to establish certain guidelines to facilitate their use. The various methods of selecting capitalization rates were discussed and, where justified, criticized. Then, theoretical aspects of gross income multipliers were considered. After a brief discussion of the data and relevant statistical concepts, extensive empirical analysis, using regression and correlation models as well as the average multiplier, followed. Assuming that the objective of a capitalization device is to predict a market value, the most probable selling price, it follows that capitalization rates should be market determined. It was found that the traditional methods of rate selection did not meet the criterion of market determination. The impossibilities of selecting rates from the market were stressed. The original advantages of gross income multipliers were simplicity and data availability. Despite the traditional criticisms, the statistical analysis demonstrated another advantage, accuracy. Stratification by basic structural type, location, number of suites and income per suite resulted in average percentage differences between actual and estimated values as low as three per cent. Other results were within acceptable error limitations. The findings with regard to capitalization rates illustrate that inconsistencies and irrationalities exist in appraisal theory. The use of the traditional methods of selecting capitalization rates should be terminated as they do not result in market determined rates. The findings with regard to gross income multipliers illustrate that they are capable of predicting values very accurately in many cases. Their use is to be encouraged where it can be shown that they are accurate.

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