Real Estate Investment Chapter 12 Comparison Screening © 2011 Cengage Learning

Key Terms Appraisal Breakeven ratio Cap rate or discount rate Cash flow before taxes Cash-flow-to-equity ratio Dividend growth model Equity dividend rate or cash-on-cash return Gross operating income (GOI)

© 2011 Cengage Learning Key Terms Leasing commissions and tenant improvements Net operating income (NOI) Operating expense ratio Operating expenses Operating income Potential gross income Profitability ratio Relative spread Under water

© 2011 Cengage Learning Popular Guidelines Income multipliers Gross Income Multipliers Denotes the fact that the value of an income property relates directly to the property’s income. Difficulty with GIM is the lack of consideration of expenses.

© 2011 Cengage Learning Popular Guidelines Cash on cash ROE This method determines the equity the cash remaining from income after all expenses and debt service have been paid (the net cash flow) ROE = Equity/Net Cash Flow

© 2011 Cengage Learning Popular Guidelines Per-Unit Value Market value Construction cost Square-Foot Valuation Both rental income and operating expenses are readily reduced to an amount per square foot of space.

© 2011 Cengage Learning Property Income and Expense Analysis A suggested form—listing all major account headings for income and expenses, and using nomenclature recommended by the NAR—is reproduced as Figure The form can be used for either a preliminary comparison of properties, or as a basis for studying operating problems.

© 2011 Cengage Learning A Standard Form for Comparison Analysis By using percentages, the critical items can be quickly identified. To make a comparison with other similar investments, the standard format clarifies the income figures and operating costs by using the same account nomenclature. The not-so-obvious accounts that require special attention are management, replacement allowance, and repairs.

© 2011 Cengage Learning Other Ratios Profitability Ratio PR = NOI /TCI Cash-Flow-to-Equity Ratio CFER = NCF/Equity For Studying Operating Problems Percent of GOI Column

© 2011 Cengage Learning Other Comparison Methods Operating Expense Ratio OER = Expenses/GOI Other Analysis Problems Accounting Detail Replacement Allowance Verification of Data

© 2011 Cengage Learning Other Comparison Methods Net Operating Income (NOI) Income Growth and the Dividend Growth Model R = D1/P0 + G

© 2011 Cengage Learning Property Appraisals Appraiser Qualification Home Values and Appraisals and the Financial Crisis Appraisal Approaches to Value

© 2011 Cengage Learning Cost Approach Replacement Cost Depreciation Physical deterioration Functional obsolescence Economic (or external) obsolescence Land Value

© 2011 Cengage Learning Market Approach Concentrates on the sales prices of similar properties. Appraiser determines the plus or minus value factor of each major difference between the subject property and each similar property. Comparisons are comprehensive, covering such points as location, size, physical condition, age, and amenities. Only actual sales prices reflect actual market values.

© 2011 Cengage Learning Income Approach Most important analysis for a commercial property. For many investors, it is the only acceptable approach because it bases value strictly on the profitability of the property. The first step in this approach is to calculate the property’s NOI. V = NOI/R

© 2011 Cengage Learning Appraisal Conclusion An appraiser uses all three approaches to value whenever practical. Some properties do not provide sufficient data to allow all three methods. For example, a city hall appraised for insurance coverage would rely mostly on a cost approach to value. Using all three approaches for the same property generally produces three different estimates of value.

© 2011 Cengage Learning Feasibility Report Conclusions Property Market evaluation Environmental effect Income and expenses

© 2011 Cengage Learning Physical Inspection The general appearance of the property. The nature of the surrounding area, neighboring buildings, and use of the land in that area. The general traffic patterns in the vicinity of the subject property. Land drainage around the property—a visit during or shortly after a rainstorm can be illuminating.