Transcript CHAPTER ONE

CHAPTER TEN
VALUATION OF INCOME
PROPERTIES: APPRAISAL AND
THE MARKET FOR CAPITAL
Market Value
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Motivated buyer and seller
Well informed buyer and seller
A reasonable time period
Payment in cash or cash equivalent
Arms length transaction
Appraisal Process
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Physical and legal identification
Identify property rights
Purpose of the appraisal
Specify effective date of value
estimate
• Apply techniques to estimate value
Income Approach
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GIM
Direct capitalization method
Discount present value method
Note- the first two methods rely on
current market transactions
Gross Income Multiplier
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PGI*
Less V and C
EGI
Less OP
NOI
GIM= sales price/ gross income*
Capitalization Rate
• V= NOI/ R
• NOI can be compared with transaction
prices to derive R
• Sometime called market extraction
method
Operating Expenses
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Real estate taxes
Insurance
Utilities
Repair and maintenance
Admin. and general
Mgnt. and leasing
Salaries
Reserves
other
Discounted PV
• Discount rate (r)
• Required return for a real estate
investment based on its risk when
compounded with other investments
• Time period 5, 7, 10 years
• A forecast of NOI
• Estimate reversion value
Simple Formula
• Present value of an increasing annuity
• Value= NOI1/ (discount rate- growth rate)
– NOI1 is Net Operating Income (rent less
expensive) during the first year of ownership
– Discount rate is the required rate of return (IRR)
– Growth rate is the expected growth in income
• Same idea as Gordon Dividend Discount
Model (see
www.DividendDiscountModel.com)
• Simple model assumes income and value
will grow at the same rate forever (or until
sold)
Example
• An apartment building is expected to
generate NOI of $100,00 the first year.
Rents and expenses are expected to grow at
2% per year until sold after 5 years. The
value of the property is expected to increase
with income. Investors require a 12% rate of
return. What is the value?
• Value= $100,000/ (12%-2%)= $1,000,000
Concept of a Capitalization
Rate
• Capitalization rate (“cap rate”)= NOI1/ value
– Ratio of first year income to value
• Rearrange equation: value=NOI1/cap rate
• Two ways to think about getting a cap rate:
• Formula: cap rate= discount rate- growth rate e.g., in
previous example, cap rate= 12%-2%= 10%
• Comparable sales: cap rate=NOI1/ sale price where the
sale price is from comparable properties e.g., another
property sold for $1,200,000 and was expected to have
NOI the first year of $120,000
Beyond the Simple Formula
• Project the NOI for each year of a
holding period
• Project resale price at the end of the
holding period
• Discount the NOI and resale to get
present value
Example
• Income is expected to be $100,000 per
year for the next 5 years due to
existing leases. Starting in year 6 the
income is expected to increase to
$120,000 due to lease rollovers and
increase at 2% per year thereafter.
Investors want a 12% return. What is
the value?
Solution
• First estimate resale using cap rate concept
– Resale or “terminal” cap rate= 12%-2%= 10%
– Apply this to income in year 6 ( first year of
ownership to next owner)
– Resale= ($120,000)/ .10= $1,200,000
• Now discount the NOI and resale price
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PMT= $100,000
FV= $1,200,000
n= 5
i= 12%
• Note that the “going in cap rate” would be
100,000/ $1,041,390= 9.6%
Year
1
NOI
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100,000
3
100,000
4
100,000
NPV @12%
100,000
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100,000
120,000
1,200,000*
Resale
Cash
Flow
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100,000
100,000
$1,041,390
100,000
100,000 1,300,000
*Yr 6 NOI/ terminal cap rate of 120,000/ .10
Reversion Values
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Expected L-T cash flows
REV9= (NOI10)/ (r-g)
Directly from sales transaction data
Resale based on expected change in
property values
Highest and Best Use Analysis
• PV= NOI1/ r-g or NOI1/r
• PV- BLDG cost= land value
Mortgage Equity
Capitalization
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V= M+E
DS= NOI1/ DCR
Calculate M
Calculate E (PVA + CF)
PV= M + E
Cap Rates and Market
Conditions
• Lower cap rates (higher property values)
• Unanticipated increases in demand relative
to supply
• Higher cap rates (lower property values)
• Unanticipated increases in supply relative to
demand
• Unanticipated increases in interest rates