Transcript The Income Capitalization Approach

Chapter 22
The Student Handbook to
THE APPRAISAL OF REAL ESTATE
Direct Capitalization
1
Capitalization Rates



The ratio of the sale price to the expected net income for
the next year
May be extracted from comparable sales
Other methods can be used to support capitalization rate
Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 22
2
Derivation of Overall Capitalization Rates



From comparable sales
 RO = NIR/EGIM
By band of investment
 Mortgage and equity
 Land and building
Debt coverage formula (mortgage underwriters method)
 DCR = NOI/RM
 RO = M x RM x DCR
 DCR = NOI/ADS
Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 22
3
Band of Investment—Mortgage and Equity
M (Mortgage ratio)
(1 – M)
x RM
x RE
Weighted Amount
+ Weighted Amount
RO
The mortgage constant R M can be calculated by dividing the annual debt
services (ADS) by the initial amount of the mortgage. It can also be
calculated on the financial calculator as follows:
N=
25 x 12
I/YR =
10/12
PV =
-1
FV =
0
Solve for PMT
RM = PMT x 12
0.75
0.25
0.009087
0.10904
x 0.10904
=
x 0.13000
0.08178
=
0.11428
0.03250
Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 22
4
Band of Investment—Land and Building
L
x RL =
Weighted Amount
B
x RB =
+ Weighted Amount
RO
0.75
x 0.1300 =
0.09750
0.25
x 0.0900 =
+ 0.0225
0.120 or 12.00%
Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 22
5
Debt Coverage Formula
RO =
RO =
M x RM x DCR
0.75 x 0.10797 x 1.2
RO =
100,000 /0.09717 =
0.09717
$1,029,124
Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 22
6
Residual Techniques
The subject has NOI of $45,000/year. The V
L
is $95,000.
The RL is 9% and the RB is 12%. What is the property value?
95,000 (V L)
x 0.09 (R L) =
$8,550 (I L)
$45,000 (NOI)
– 8,550 (I L)
= 36,450 (I B)
$36,450 (I B)
/ 0.12 (R B) =
$303,750
$303,750
+ 95,000 =
$398,750
Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 22
7
Gross Income Multipliers and Gross Rent
Multipliers

Conditions
 Buyers think this way
 Similar expense ratios
 Similar upside potential
Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 22
8
Sale and Rent Comparable Worksheet
Sale price
Gross rent estimate
GRM
1
$280,000
$2,500
112.00
2
320,000
2,900
110.34
3
305,000
2,750
110.91
4
275,000
2,500
110.00
5
330,000
2,900
113.79
6
325,000
2,900
112.07
7
300,000
2,700
111.11
8
298,000
2,700
110.37
9
285,000
2,500
114.00
10
290,000
2,750
105.45
Average
300,800
2,710
111.01
Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 22
9
Problems

Suggested solutions begin on page 430.
Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 22
10
Problems 1 and 3—Suggested Solutions
Problem 1
Sale Price
NOI
IM
75,000
75,000
Sale 1
1,000,000
98,000
9.80%
/
/
Problem 3
PGI
V&C
EGI
Fixed
Variable
Net income
33,000 /0.12
Sale 2
750,000
75,000
10.00%
0.0975
0.1000
Sale 3
650,000
62,500
9.62%
=
=
Sale 4
500,000
49,500
9.90%
$ 769,231
$ 750,000
100,000
-7,000
93,000
-35,000
-25,000
$33,000
= 275,000
Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 22
11
Problems 5 and 6—Suggested Solutions
QuickTime™ and a
TIFF (LZW) decompressor
are needed to see this picture.
QuickTime™ and a
TIFF (LZW) decompressor
are needed to see this picture.
Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 22
12
Problems 7, 8, and 9—Suggested Solutions
Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 22
13
Problem 10—Suggested Solution
Sale 1
PGI = 23,040 EGI = 21,888 NOI = 14,488 RO = 0.0827
Sale 2
PGI = 20,280 EGI = 19,266 NOI = 12,516 RO = 0.0834
Sale 3
PGI = 19,980 EGI = 18,981 NOI = 12,381 RO = 0.0853
Sale 4
PGI = 19,800 EGI = 18,810 NOI = 12,360 RO = 0.0797
Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 22
14
Problem 10—Suggested Solution
Estimated PGI
Unit 1
Unit 2
Unit 3
Unit 4
Monthly estimated rent
Annual potential gross income
Vacancy and collection loss
Effective gross income
Expenses
Taxes
Insurance
Variable expenses
Reserves for replacement
Net operating Income
Capitalized value
$485
$500
$450
$435
$1,855
6.00%
$2,800
$2,200
$2,200
$$7,200
$13,724
$22,260
-$1,336
$20,924
-$7,200
$13,724
/ 0.08 = $171,555
Student Handbook to THE APPRAISAL OF REAL ESTATE
Chapter 22
15