1 chapter 10 valuation of income properties: appraisal and the market for capital
TRANSCRIPT
![Page 1: 1 Chapter 10 Valuation of Income Properties: Appraisal and the Market for Capital](https://reader036.vdocument.in/reader036/viewer/2022062407/56649dc85503460f94abe28a/html5/thumbnails/1.jpg)
1
Chapter 10
Valuation of Income Properties: Appraisal and the
Marketfor Capital
![Page 2: 1 Chapter 10 Valuation of Income Properties: Appraisal and the Market for Capital](https://reader036.vdocument.in/reader036/viewer/2022062407/56649dc85503460f94abe28a/html5/thumbnails/2.jpg)
2
Overview Valuation Fundamentals Appraisal Process Sales Comparison Approach Income Approach
Gross income multiplier (GIM) Capitalization rate Discounted cash flow
Highest & Best Use Mortgage-Equity Capitalization Cost Approach
![Page 3: 1 Chapter 10 Valuation of Income Properties: Appraisal and the Market for Capital](https://reader036.vdocument.in/reader036/viewer/2022062407/56649dc85503460f94abe28a/html5/thumbnails/3.jpg)
3
Valuation Fundamentals
Market Value Most probable price Open market and fair sale Knowledgeable buyer and seller Arms length transaction Normal financing
![Page 4: 1 Chapter 10 Valuation of Income Properties: Appraisal and the Market for Capital](https://reader036.vdocument.in/reader036/viewer/2022062407/56649dc85503460f94abe28a/html5/thumbnails/4.jpg)
4
Appraisal Process An appraisal is an estimate of value It is used as the basis of lending and investing
decisions Appraisal Process:
Physical and legal definitions Identify property rights to be valued Specify the purpose of the appraisal Specify the effective date of value estimate Gather and analyze market data Apply techniques to estimate value
Three approaches of appraisal Sales comparison approach Income capitalization approach Cost approach
![Page 5: 1 Chapter 10 Valuation of Income Properties: Appraisal and the Market for Capital](https://reader036.vdocument.in/reader036/viewer/2022062407/56649dc85503460f94abe28a/html5/thumbnails/5.jpg)
5
Sales Comparison Approach
Use data from recently sold “comparables” to derive a “subject” market value
Adjust comparable sales price for feature differences
Principles of contribution & substitution Lump sum adjustments and square foot
adjustments Subjective process
![Page 6: 1 Chapter 10 Valuation of Income Properties: Appraisal and the Market for Capital](https://reader036.vdocument.in/reader036/viewer/2022062407/56649dc85503460f94abe28a/html5/thumbnails/6.jpg)
6
Sales Comparison Approach
![Page 7: 1 Chapter 10 Valuation of Income Properties: Appraisal and the Market for Capital](https://reader036.vdocument.in/reader036/viewer/2022062407/56649dc85503460f94abe28a/html5/thumbnails/7.jpg)
7
Sales Comparison Approach
![Page 8: 1 Chapter 10 Valuation of Income Properties: Appraisal and the Market for Capital](https://reader036.vdocument.in/reader036/viewer/2022062407/56649dc85503460f94abe28a/html5/thumbnails/8.jpg)
8
Income Approach
The value of a property is related to its ability to produce cash flows Gross income multiplier (GIM) Capitalization rate Discounted cash flow
![Page 9: 1 Chapter 10 Valuation of Income Properties: Appraisal and the Market for Capital](https://reader036.vdocument.in/reader036/viewer/2022062407/56649dc85503460f94abe28a/html5/thumbnails/9.jpg)
9
Gross Income Multiplier Determine comparable property GIM as:
Apply GIM to the subject property If GIM = 6.00x and the subject has gross
income = $120,000 then Value Estimate = 6.00 x $120,000 = $720,000
Income Gross
Price SalesGIM
1 2 3
Sales Price $600,000 $750,000 $450,000
Gross Income $100,000 $128,000 $74,000
GIM 6.00x 5.86x 6.08x
![Page 10: 1 Chapter 10 Valuation of Income Properties: Appraisal and the Market for Capital](https://reader036.vdocument.in/reader036/viewer/2022062407/56649dc85503460f94abe28a/html5/thumbnails/10.jpg)
10
Capitalization Rate If comparable properties have different
operating expenses then instead of GIM, net operating income (NOI) should be used
R
NOIValue
1 2 3 4
Sales Price $368,500
$425,000
$310,000
$500,000
NOI $50,000 $56,100 $42,700 $68,600
R 0.1357 0.1320 0.1377 0.1372
![Page 11: 1 Chapter 10 Valuation of Income Properties: Appraisal and the Market for Capital](https://reader036.vdocument.in/reader036/viewer/2022062407/56649dc85503460f94abe28a/html5/thumbnails/11.jpg)
11
Capitalization Rate – Continued
Capitalization Rate Range: 0.1320 < R < 0.1377
The cap rate choice is an educated opinion of the appraiser
Which property is most similar to the subject?
If the subject NOI = $58,000, the value estimate could be: $58,000 / 0.1320 < V < $58,000 / 0.1377 $421,205 < V < $439,394
Care must be taken when determining R
![Page 12: 1 Chapter 10 Valuation of Income Properties: Appraisal and the Market for Capital](https://reader036.vdocument.in/reader036/viewer/2022062407/56649dc85503460f94abe28a/html5/thumbnails/12.jpg)
12
Capitalization Rate – Continued Considerations when determining R Consider the comparables
Similarity to subject Physical attributes Location Lease terms Operating efficiency
How is NOI determined? Stabilized NOI Nonrecurring capital outlays
Lump sum Averaged
Was NOI skewed by a one-time outlay?
![Page 13: 1 Chapter 10 Valuation of Income Properties: Appraisal and the Market for Capital](https://reader036.vdocument.in/reader036/viewer/2022062407/56649dc85503460f94abe28a/html5/thumbnails/13.jpg)
13
Discounted Present Value
Compute the present value of future cash flows Forecast NOI and holding period Select discount rate based on risk and
return of comparable investments (r) Determine reversion value of property
![Page 14: 1 Chapter 10 Valuation of Income Properties: Appraisal and the Market for Capital](https://reader036.vdocument.in/reader036/viewer/2022062407/56649dc85503460f94abe28a/html5/thumbnails/14.jpg)
14
Discounted Present Value – Discount Rate
![Page 15: 1 Chapter 10 Valuation of Income Properties: Appraisal and the Market for Capital](https://reader036.vdocument.in/reader036/viewer/2022062407/56649dc85503460f94abe28a/html5/thumbnails/15.jpg)
15
Discounted Present Value – Reversion Value
Estimating reversion value Not an exact science Method 1: Discount remaining cash flows using a
terminal cap rate (RT) RT = (r – g) constant positive growth (g) RT = (r) growth is zero RT = (r + g) growth is a decay rate
Method 2: Estimate RT by adjusting the “going in” cap rate
RT > going in cap rate This is because as properties age their income
generation potential diminish Method 3: Estimate resale value from expected
changes in property value
![Page 16: 1 Chapter 10 Valuation of Income Properties: Appraisal and the Market for Capital](https://reader036.vdocument.in/reader036/viewer/2022062407/56649dc85503460f94abe28a/html5/thumbnails/16.jpg)
16
Discounted Present Value – Example
A property has a projected year 1 NOI of $200,000. NOI is projected to grow by 4.00% per year for the following 2 years, then by 2.00% per year for the subsequent 2 years at a 1.00% constant rate afterward. Given a required return of 13.00%, what is the value of the property? NOI1 = $200,000 NOI2 = $208,000 NOI3 = $216,320 NOI4 = $220,646 NOI5 = $225,059 Constant 1.00% growth begins
![Page 17: 1 Chapter 10 Valuation of Income Properties: Appraisal and the Market for Capital](https://reader036.vdocument.in/reader036/viewer/2022062407/56649dc85503460f94abe28a/html5/thumbnails/17.jpg)
17
Discounted Present Value – Example
Terminal Value = $1,894,250
Cash flows: NOI1 = $200,000 NOI2 = $208,000 NOI3 = $216,320 NOI4 = $220,646 NOI5 = $225,059 + $1,894,250 PV @ 13.00% = $1,775,409
250,894,1$
0.010.13
$227,3100.011$225,059
gr
NOI Value Terminal 6
5
![Page 18: 1 Chapter 10 Valuation of Income Properties: Appraisal and the Market for Capital](https://reader036.vdocument.in/reader036/viewer/2022062407/56649dc85503460f94abe28a/html5/thumbnails/18.jpg)
18
Highest & Best Use Land value: The residual land value is the difference
between total property value driven by rents and cash flows less cost of constructing an improvement on a given site
Sources of land price volatility Speculation Changes in valuation of improvements that can be built on
the land Residual Land Value
PV – Building Cost = Land Value Step 1: Compute the present value of the estimated cash
flows for all alternatives Step 2: Subtract building cost Step 3: Select highest value among the alternatives
![Page 19: 1 Chapter 10 Valuation of Income Properties: Appraisal and the Market for Capital](https://reader036.vdocument.in/reader036/viewer/2022062407/56649dc85503460f94abe28a/html5/thumbnails/19.jpg)
19
Highest & Best Use – Continued
![Page 20: 1 Chapter 10 Valuation of Income Properties: Appraisal and the Market for Capital](https://reader036.vdocument.in/reader036/viewer/2022062407/56649dc85503460f94abe28a/html5/thumbnails/20.jpg)
20
Mortgage-Equity Capitalization
Value = PV of Mortgage Financing + PV of Equity Investment
Steps: Estimate NOI Subtract Debt Service from NOI Subtract Mortgage Balance from Resale
Value Discount Cash Flows Add Present Value of Cash Flows to Mortgage
![Page 21: 1 Chapter 10 Valuation of Income Properties: Appraisal and the Market for Capital](https://reader036.vdocument.in/reader036/viewer/2022062407/56649dc85503460f94abe28a/html5/thumbnails/21.jpg)
21
Mortgage-Equity Capitalization – Continued
![Page 22: 1 Chapter 10 Valuation of Income Properties: Appraisal and the Market for Capital](https://reader036.vdocument.in/reader036/viewer/2022062407/56649dc85503460f94abe28a/html5/thumbnails/22.jpg)
22
Mortgage-Equity Capitalization – Continued
PV of total cash flow @ 12.00% = $165,566 Financing is based on debt coverage ratio
(DCR) of 1.20 and first year NOI of $50,000. Debt service (DS) = $50,000 / 1.20 = $41,667 Monthly payment = $41,667 / 12 = $3,472 If the loan rate is 11.00% for 20 year then the
loan amount is $336,394 Property value = $336,394 + $165,566 =
$501,960
![Page 23: 1 Chapter 10 Valuation of Income Properties: Appraisal and the Market for Capital](https://reader036.vdocument.in/reader036/viewer/2022062407/56649dc85503460f94abe28a/html5/thumbnails/23.jpg)
23
Valuation Fundamentals Reconciliation of Value Estimates
The sales comparison and income approaches should yield similar value estimates.
Market Conditions Changes on “Going in” Cap Rates Supply & Demand pressures Capital market changes Capital market & spatial market changes
![Page 24: 1 Chapter 10 Valuation of Income Properties: Appraisal and the Market for Capital](https://reader036.vdocument.in/reader036/viewer/2022062407/56649dc85503460f94abe28a/html5/thumbnails/24.jpg)
24
Cost Approach Buyer would not pay more than the
value of land plus cost of building the structure
Estimate the construction cost if new Subtract depreciation
Physical Functional External
Add site value