1. Direct Capitalization

2. Capitalization Rates
The ratio of the sale price to the expected net income for the next year
May be extracted from comparable sales
Other methods can be used to support capitalization rates
Chapter 23

3. Derivation of Overall Capitalization Rates
From comparable sales
RO = NIR / EGIM
By band of investment
Mortgage and equity
Land and building
Debt coverage formula (mortgage underwriters method)
DCR = IO / IM
RO = M x RM x DCR
DCR = IO / ADS
Chapter 23

4. Band of Investment—Mortgage and Equity
Chapter 23

5. Band of Investment—Land and Building
Chapter 23

6. Debt Coverage Formula
Chapter 23

7. Residual Techniques
The subject has a NOI of $45,000/year. The VL is $95,000. The RL is 9%, and the RB is 12%. What is the property value?
95,000 (VL)+
× 0.09 (RL) =
$8,550 (IL)
$45,000 (NOI)
- 8,550 (IL) =
36,450 (IB)
$36,450 (IB)
/ 0.12 (RB) =
$303,750
+ 95,000
$398,750
Chapter 23

8. Gross Income Multipliers and Gross Rent Multipliers
Conditions
Buyers think this way
Similar expense ratios
Similar upside potential
Chapter 23

9. Sale and Rent Comparable Worksheet Solution
Sale Price
Gross Rent Estimate
GRM 1
$280,000
$2,500
112 2
$320,000
$2,900
110.34 3
$305,000
$2,750
110.91 4
$275,000
110 5
$330,000
113.79 6
$325,000
112.07 7
$300,000
$2,700
111.11 8
$290,000
107.41 9
$285,000
114 10
105.45
Average
$300,800
$2,710
110.71
The market value of the subject property is
$2,750 × = $304,452.50
Chapter 23

10. Suggested Solutions to Review Exercises
Problem 1 •
Sale 1 sold for $1,000,000 and has an annual net
income expectancy of $98,000 = 0.098
Sale 2 sold for $750,000 and has an annual net
income expectancy of $75,000 = 0.10
Sale 3 sold for $650,000 and has an annual net
income expectancy of $62,500 =
Sale 4 sold for $500,000 and has an annual net
income expectancy of $49,500 = 0.099
75,000/0.10 = $750,000
Problem 3
PGI
$100,000
Vacancy and collection loss
− ,000
EGI
$93,000
Fixed expenses
$35,000
Net income
$33,000
$33,000/0.12 =
$275,000
Chapter 23

11. Suggested Solutions, continued
Chapter 23

12. Review Exercise 10.Suggested Solution
Comparable Sale 1
PGI =
$23,040
EGI =
$21,888
NOI =
$14,488
RO =
Comparable Sale 2
$20,280
$19,266
$12,516
0.0834
Comparable Sale 3
$19,980
$18,981
$12,381
Comparable Sale 4
$19,800
$18,810
$12,360
Again, this is one solution, not the only solution. There is some room for interpretation in the income and expense estimates. Students should have an answer similar to this, but there will be some variations due to judgment calls.
Chapter 23

13. Review Exercise 10. Suggested Solution, continued
Estimated PGI
Unit 1
$485
Unit 2
485
Unit 3
450
Unit 4
435
Monthly estimated rent
$1,855
Annual potential gross income
$22,260
Vacancy and collection loss
6.00%
− ,336
Effective gross income
$20,924
Expenses
Taxes
$2,800
Insurance
$2,200
Variable expenses
Reserves for replacement
= —
Total expenses
$7,200
− ,200
Net operating income
$13,724
Capitalized value
$13,724/0.08 =
$171,550
Chapter 23