most like Oakwood, sold for $110,000 per unit. Although the appraiser is not doing a formal sales comparison approach, she notes that a price of $110,000 per unit would suggest a value of Oakwood of $110,00095=$10,450,000. The appraiser has determined that the number of units per acre (usually set by zoning) is currently the maximum allowable. This may be important if zoning laws have changed and now allow development of 20 or more units per acre. The average number of parking spaces (2.10) per unit, or 400 spaces, seems reasonable relative to the competition, and the appraiser has determined that the amenity package is appropriate relative to rental rates and to what the competition is currently offering in the way of exercise and recreation facilities, TV cable/ satellite services, high-speed Internet connectivity, washer/dryer hookups, and so on. On-site expenses will include salaries for on-site personnel who maintain and "make units ready" for tenants in the community. An operating risk that must be considered by apartment investors is the relatively short nature of lease maturities, the potential tenant turnover, and downtime due to vacancies. Experience in large metropolitan areas indicates that as many as 60 percent of apartments in a given property may turn over each year. In making cash flow projections, analysts must consider turnover-related losses in revenue because of vacancies, in conjunction with recurring repairs and maintenance expenses involved in making units ready for new tenants. For Oakwood Apartments, these items are included in repair and maintenance expense. A management fee for oversight of all leasing, rent collection, tenant relations, and so on, and office expenses for payroll, insurance, tax property, and other bookkeeping services necessary for operations have also been estimated. These items should be validated from payment records and/or the appropriate agency or vendors. Vacancy is expected to be 5 percent of potential income, and credit loss due to tenants who default on their lease is expected to be an additional 1 percent of potential income. The property is to be valued as of January 1,2000 . The property is to be valued using an 11 percent discount rate and assuming the property will be sold after five years. The resale price will be estimated by using a 9 percent terminal capitalization rate applied to year 6 NOI. The rate reflects lower growth expectations after year 5. Selling costs when the property is sold will be 5 percent of the sale price. Rents are expected to be $1,250 when leases are renewed after one year and increase at the expected inflation rate of 3 percent per year thereafter. Additional revenue of $120 per unit is expected from the laundry machines that are included in a laundry area of the apartment complex. This income will also increase at 3 percent per year. Contrary to most other property types, tenants occupying apartment properties usually sign leases with maturities of either 6 or 12 months. Furthermore, tenants usually pay for their own utilities, insurance, and so on, which usually relieves the investor of making payments for these items and recovering expenses from tenants. However, there are utility costs for common areas in the apartment community that must be paid by the owner. Expenses next year are projected as follows: Real estate taxes are expected to increase by 2.5 percent per year and all other expenses are projected to increase at the inflation rate of 3 percent per year. Oakwood Apartments is a luxury apartment complex. It is being appraised for an investor who has contracted to purchase the property and needs to obtain financing. The bank has had its own staff appraisers estimate the value of the property but wants an independent appraiser to also provide an estimate using a "limited appraisal" that focuses on the income approach. The bank has provided Exhibit 10-16, which summarizes information about the property. The appraiser has confirmed the expected rent per unit with the present owner, and she has also done an analysis of comparable apartment communities that is summarized in Exhibit 10-17. Oakwood consists entirely of two-bedroom units. A competitive analysis indicates that Oakwood is very similar to comparables 1 and 2 even though they each have some one- and three-bedroom units. It appears that owners of apartment buildings with a greater proportion of two-bedroom units are able to get a higher average monthly rent per unit. Comparable 3 is more densely developed with one-bedroom apartments, and its parking ratios are lower than all others. It appears that the average rent for Oakwood is reasonable relative to the competition. In addition to rent, other cash flows may be realized from laundry facilities. Comparable 2 sold for $100,000 per unit, and comparable 1 , which is EXHIBIT 10-16 Property Information- Oakwood Apartments In addition to the above expenses a property management firm is paid 12 percent of effective gross income (rents less vacancy and credit loss) to find tenants, sign leases, handle tenant relations, and oversee repairs and maintenance. Based on the assumptions above, cash flows for Oakwood Apartments are projected in Exhibit 10-18. NOI is projected through year 6 since year 6 is used to estimate the resale price. Exhibit 10-19 shows the projected resale price by applying the 9 percent terminal capitalization rate to the year 6NOI and subtracting the selling costs of 5 percent of the sale price. Exhibit 10-20 shows the present value of the NOI over the five-year holding period plus the present value of the resale calculated above. Present values are based on an 11 percent discount rate. The total value is $10,548,557, or $10,549,000 (rounded). This is just slightly more than the replacement cost of $10,000,000 and about the same as the price that would be indicated by the price per unit from the comparable sales, which was $10,450,000