Two Approaches, Two Different Answers
You are valuing a 24-unit apartment building in a California suburban market. The sales comparison approach, using five recent sales of similar apartment buildings, indicates about $4,600,000 after adjustments. Your income approach uses a market-derived overall capitalization rate of 5.25 percent applied to a stabilized net operating income of $252,000, producing $4,800,000. You also ran a gross rent multiplier check that supports roughly $4,700,000. The subject has below-market rents on 10 of 24 units because the owner has not raised them in four years; current market rents would add about $38,000 of annual gross income. The lender's reviewer questions why the two approaches differ by $200,000 (about 4.3 percent).
1. Which value indicator should you weight most heavily, and why?
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For an income-producing apartment building, investors buy the income stream, so the income approach deserves primary weight. The sales comparison approach is still meaningful but is a secondary check, especially when the comparables are similar in unit count and condition.
The $200,000 spread is only about 4.3 percent, which is within normal appraisal tolerance, so it does not by itself signal an error. Before weighting, reconcile the inputs. The income approach must use stabilized market rent, not the owner's below-market contract rents, or the resulting value will understate the property. If $252,000 of NOI is based on contract rents, you must adjust it upward to market, which would push the income indicator higher and widen the gap - so verify that the $252,000 already reflects market rent.
Also check that the comparables were adjusted for rent levels and expense ratios; a sale with below-market rents would sell at a discount that must be adjusted. Conclude by explaining the weighting in the report rather than simply averaging.
2. What is the risk of using a 5.25 percent overall capitalization rate derived only from the five comparables?
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An overall rate is only valid when applied to a comparable income stream and comparable risk. If the five comparables had newer roofs, lower vacancy, or were in stronger submarkets, their 5.25 percent rate reflects lower risk than the subject, and applying it to the subject's NOI would overstate value.
You should verify how each rate was derived (NOI divided by sale price, using the same NOI definition you use for the subject), confirm the comparables' vacancy and collection loss, reserves, and expense treatment, and consider whether any sale involved unusual financing or concessions. You should also test the rate with a band-of-investment or mortgage-equity check, and consider a sensitivity range (for example, 5.0 to 5.5 percent) to show how value moves with the rate. A single point estimate presented without support invites a reviewer's challenge.