VALUATION BY INCOME CAPITALIZATION LEARNING OBJECTIVES Explain the difference between appraisal and investment analysis. Estimate the NOI in a reconstructed.

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Presentation transcript:

VALUATION BY INCOME CAPITALIZATION LEARNING OBJECTIVES Explain the difference between appraisal and investment analysis. Estimate the NOI in a reconstructed operating statement. Identify the two main components of capitalization rates.

VALUATION BY INCOME CAPITALIZATION LEARNING OBJECTIVES Calculate overall capitalization rates by the general formula, market extraction, and mortgage-equity analysis Estimate a property’s market value by direct capitalization, using an overall rate. Estimate the market value of a leased fee estate, using DCF analysis.

VALUATION MODELS IN THE INCOME APPROACH Discounted Cash Flow Analysis value estimated as: the present value of the expected cash flows Investment value uses the expected cash flows and discount rate of a particular investor. Market value uses the expected cash flows and discount rate of the typical market participant. Direct Capitalization value estimated as: V = NOI / R

DCF: Expected Cash Flows (NOIs) from Operations

DCF: Expected Net Proceeds from Sale

Present Value of Expected Cash Flows (before debt)

DCF using Expected Before- Tax Cash Flows Assume the following loan terms available to a particular investor: loan-to-value ratio = 80%, thus, loan amount = $944,000 x 0.80 = $755,200 interest rate is 9.5%, amortized over 30 years, paid monthly thus, annual debt service = $6,350 x 12 = $76,202 Assume the return required of the investor is 18 percent

DCF: Expected BTCFs from Operations

DCF: Expected BTER from Sale

Present Value of Expected Cash Flows (BTCFs)

DIRECT CAPITALIZATION The Income Capitalization Equation is: V = I / R, whereV = value, I = income, and R = capitalization rate. Often used to estimate R, when V and I are known. R = I / V

The Reconstructed Operating Statement Potential Gross Income Vacancy and Collection Losses Expenses fixed variable reserves and other nonrecurring expenses expense exclusions Net Operating Income

The Reconstructed Operating Statement

Direct Capitalization Estimate The Income Capitalization Equation is: V = I / R, whereV = value, I = income, and R = capitalization rate. Assume capitalization rate is estimated to be 9.2% Indicated value using the direct income capitalization approach: V = $ 86,600 /.092 = $ 934,783 rounded to $ 934,800

Capitalization Rates and Yield Rates The overall capitalization rate can be explained as: R O = y O - g, where R O = the overall capitalization rate y O = the discount rate (or yield rate), and g = the expected annual compounded rate of growth.

Capitalization Rates

Direct Market Extraction of R O

Simple Mortgage-Equity Analysis R O = [mR m + (1-m)R e ], where R O = the overall capitalization rate, m = loan-to-loan ratio, R m = mortgage capitalization rate, and R e = equity capitalization rate.

Mortgage-Equity Analysis Example