Expenses.

Net rents.

Low retail or wholesale buildings ...........

10-25%

90-75%

Residences ...............

20-30%

80-70%

Non- elevator office buildings ..............

25-35%

75-65%

Tenements, non- elevator and elevator ...........

25-45%

75-55%

Elevator apartments........................

40-55%

60-45%

Fireproof office buildings ...................

40-55%

60-45%

It is clear that the lower the cost of the building in proportion to the value of the land, the nearer the income approaches to pure ground rent, against which the sole charge is taxes. On the other hand, the more expensive the building the higher the maintenance cost, owing both to the greater number of services rendered and to the higher standard of accommodation. Since the operating expenses of a building, whether fully or only partly occupied, vary but slightly, the larger the proportion of expenses to gross rentals the more marked will be the rise or fall of net rentals as gross rentals fluctuate. Ordinarily, expensive office buildings are properly located, the chief errors being in the erection of expensive buildings in small cities, or in poor locations in larger cities. When hard times cause a sharp drop in rents in the smaller cities, instances have been known of the upper floors of such buildings not earning sufficient rent to pay for the mere services rendered, so that it would pay for owners to close the buildings above the ground floor, even though the ground floor stores are in active demand. The danger to owners of heavy fixed charges is shown in the following table:

With percentage of expenses to gross inc.:

If gross rents rise or fall

Then net rents rise or fall.

If gross rents rise or fall

Then net rents rise or fall.

If gross rents rise or fall

Then net rents rise or fall.

10%

20%

22%

40%

44%

60%

66%

20%

20%

25%

40%

50%

60%

75%

30%

20%

29%

40%

56%

60%

85%

40%

20%

33%

40%

66%

60%

100%

50%

20%

40%

40%

80%

60%

120%

60%

20%

50%

40%

100%

60%

150%

The next charge against gross rents is for interest on capital invested in the building, this being figured at the same rate as the capitalization of the ground rent, after an allowance for depreciation has been made.

The final residuum constitutes the economic or ground rent, which represents the competitive premium paid for location. Where there is no residuum of ground rent in city land it does not follow that the land has no value, but usually that the improvements are not suitable, so that the value must be estimated under a different utilization. If the improvement is a suitable one, absence of ground rent may be due to temporary drop in rentals or bad management, all city land normally yielding some ground rent.

With an established economic rent, the sole remaining factor to transform this into intrinsic value is the rate of capitalizatoion. As capitalization rates vary with securities, Government bonds selling below a 2% basis, railroad bonds and stocks on a 3 1/2% to 5% basis, and industrials on a 7% to 10% basis, so the rates of capitalization of urban rents vary from 4% for the highest class property in the largest cities, to 5% and 6% for second-class property in the same cities, or for first-class property in smaller cities, 7%, 8% and 10% for tenements in the largest cities, and 12% to 15% for temporary utilizations or disreputable purposes in the smaller cities. The great power of capitalization rates on values is due to the fact that for every change of 1% in the rate of capitalization, values may change from twelve to twenty-five times the difference in interest. For example, a property with a net income of $10,000 would sell on an 8% basis at $125,000, on a 6% basis at $166,000, and on a 4% basis at $250,-000. The lower the capitalization rate the greater the effect of any change of values: For example, a fall from 8% to 7% adds but 14% to the value of the property, while a fall from 5% to 4% adds 25% to the value of the property. Moreover, as large interest rates apply to the largest properties all further fractional lowering of low interest rates results in an enormous mass of values. The marked difference between capitalization rates of high class and low class property in the same city indicates the large number of people who desire to own high class property, and the few who desire to own low class property. The reason for such preference is that with high class property, rents are more stable and easily collected, the property is more quickly and certainly convertible, it can be mortgaged at a lower rate of interest and for a larger percentage of value, the buildings depreciate much less rapidly and the prospects of increase in value are better.