global real estate: transaction tools chapter 6: value concepts
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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
• 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
Page 97-98
$1000
$941
$1108
$1000
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 buildingsPage 100-101
Income Approaches
• Gross rent multiplier• Net operating income (NOI) and cash flow• Income capitalization• Cash on cash (ConC)• Net present value• Internal rate of return (IRR)
Page 101
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) $115,000- Vacancy and Credit Losses 9,900+ Other Income 700= Gross Operating Income 105,800- Expenses 22,300= Net Operating Income (NOI) 83,000
Page 103
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
Page 104
I
R V
Income
I = Income = Stabilized NOII = 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 returnfrom
– 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
Page 110
Key Point Key Point ReviewReview
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