Transcript Document

Global Real Estate:
Transaction Tools
Chapter 6: Value Concepts
In This Chapter
• Comparing values
• Sales, cost, and income approaches
• Helping buyers make informed decisions
Page 92
Investment Analysis
• Commercial investors expect detailed and
thorough analysis
• Even vacation-home buyers often view
purchase as investment
• Resource: Realtors Property Resource®
(RPR)
Page 93
Investment Elements
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Yield
Safety
Leverage
Control
Page 95-97
Time/Value of Money
• Present value of money is more than
future value
• Would you prefer $1,000 today or $1,000
in the future?
• Why isn’t the sum the same?
Page 97
Example: Time/Value of Money
$1000
Present value of $1000
in 3 years with 2%
inflation – Discounted
$941
Future Value of $1000
in 3 years growing at
3.5% – Compounded
$1108
$1000
Page 97-98
The 7/10 Rule
• How long does it take for an investment to
double in value?
• 7 years at 10%
- OR • 10 years at 7%
Page 99
The #1 Question
What is the value
of the property?
Page 100
Sales Approach
• Compare actual current market values of
similar properties
• CMA
• Single-family homes and small properties
Page 100
Cost Approaches
• Reproduction: duplication
• Replacement: reconstruction using current
materials and methods
– Comparison cost per square foot
– Segregated costs
– Quantity survey
– Index
• New, one-of-a-kind, historic buildings
Page 100-101
Income Approaches
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Page 101
Gross rent multiplier
Net operating income (NOI) and cash flow
Income capitalization
Cash on cash (ConC)
Net present value
Internal rate of return (IRR)
Gross Rent Multiplier (GRM)
• Sales price ÷ PRI = GRM
– PRI is one year
• Expressed as a number
• Compare small income and similar
properties
Page 102
Example: GRM
• Property priced at $450,000 has a monthly
PRI of $1,500 from each of 4 apartments
• GRM = Sales Price ÷ one-year PRI
• GRM = $450,000 ÷ ($1,500 x 4
apartments x 12 months)
• GRM = $450,000 ÷ $72,000
• GRM = 6.25
Page 102
Net Operating Income (NOI)
Gross Potential Rental Income (PRI)
- Vacancy and Credit Losses
+ Other Income
= Gross Operating Income
- Expenses
= Net Operating Income (NOI)
Page 102-103
Example: NOI
Gross Potential Rental Income (PRI)
- Vacancy and Credit Losses
+ Other Income
= Gross Operating Income
- Expenses
= Net Operating Income (NOI)
Page 103
$115,000
9,900
700
105,800
22,300
83,000
Cash Flow
• Cash Flow Before Taxes (CFBT) is figured
by subtracting the amount of annual debt
service from NOI
• Cash Flow After Taxes (CFAT) is figured by
subtracting income tax owed from cash
flow before taxes
Page 103
Income Capitalization (Income,
Rate, and Value)
• Market valuation of a property based upon
a one-year projection of income
– Relies on a single year’s stabilized NOI to
estimate the value
Net Operating Income (I) ÷ Capitalization Rate
(R) = Value (V)
Page 104
IRV Formula
I
R
Page 104
V
Income
I = Income = Stabilized NOI
Page 105
Rate
• R = Capitalization Rate (cap rate)
• Single rate that converts a single year’s
income into value
• Sources of cap rates
Page 105-106
Example: Finding the Cap Rate
• Retail building bought for $3.25 million
with NOI of $295,000
• Calculate the cap rate (R)
• NOI (I) ÷ Value (V) = Cap Rate (R)
• 295,000 ÷ 3,250,000 = 9.08%
• Cap rate is 9.08%
Page 107
Example: Finding Income
• Initial value of townhouse in first year of
investment at $200,000 with a cap rate of 7%
• Calculate the NOI (I)
• Value (V) × Cap Rate (R) = NOI (I)
• $200,000 (V) × 0.07 (R) = $14,000 (I)
• ($200,000 × 7% = $14,000)
• First-year NOI is $14,000
Page 107
Example: Finding Value
• Suburban office building has NOI of $200,000
and cap rate of 7%
• Calculate the market value
• NOI (I) ÷ Cap Rate (R) = Value (V)
• $200,000 ÷ 0.07 = $2,857,142.86
• ($200,000 ÷ 7% = $2,857,142.86)
• Owner might expect selling price of
$2,857,142.86
Page 107
Cash on Cash (ConC)
• Measures investor’s desired rate of return
on initial investment
• Compares equity invested in property with
cash flow, before or after taxes, from one
year
Cash Flow ÷ Initial Equity = Cash on Cash
Page 107-108
Example: Cash on Cash
• Warehouse will cost a total of $1,000,000
• Annual NOI of $95,000
• Client can get loan for $800,000 with annual debt
service payments of $77,000. The client will put
down $200,000.
• Cash Flow ÷ Initial Equity = Cash on Cash
• Before Tax Cash Flow = $95,000 NOI – $77,000
Annual Debt Service = $18,000
• $18,000 ÷ $200,000 (down payment) = 9.0%
• Cash on Cash is 9.0%
Page 108
Net Present Value (NPV)
• Calculated by subtracting:
– Present value of future cash flows
and
– Sales price discounted by the investor’s
desired rate of return
from
– Initial investment
• Result is a number, not a percentage,
which will be greater than, less than, or
equal to zero
Page 108-109
Internal Rate of Return (IRR)
• Discounts the net present value of all cash
flows to zero in order to find the actual
rate of return
• In other words, discount rate at which the
present value of an investment is equal to
the present value of the cash flow of the
investment
Page 109
Downloadable Forms
• NPV and IRR are complex calculations
• Financial calculator or pre-programmed
spreadsheet
– CCIM Institute
Page 110
For Further Study
• CCIM Institute (www.ccim.com)
• Institute of Real Estate Management
(www.irem.org)
Page 110
Key Point
Review
Page 110