1. VALUATION OF INCOME PROPERTIES: APPRAISAL AND THE MARKET FOR CAPITAL
CHAPTER TEN
VALUATION OF INCOME PROPERTIES: APPRAISAL AND THE MARKET FOR CAPITAL

2. Market Value Motivated buyer and seller Well informed buyer and seller
A reasonable time period
Payment in cash or cash equivalent
Arms length transaction

3. Appraisal Process Physical and legal identification
Identify property rights
Purpose of the appraisal
Specify effective date of value estimate
Apply techniques to estimate value

4. Income Approach GIM Direct capitalization method
Discount present value method
Note- the first two methods rely on current market transactions

5. Gross Income Multiplier
PGI*
Less V and C
EGI
Less OP
NOI
GIM= sales price/ gross income*

6. Capitalization Rate V= NOI/ R
NOI can be compared with transaction prices to derive R
Sometime called market extraction method

7. Operating Expenses Real estate taxes Insurance Utilities
Repair and maintenance
Admin. and general
Mgnt. and leasing
Salaries
Reserves
other

8. Discounted PV Discount rate (r)
Required return for a real estate investment based on its risk when compounded with other investments
Time period 5, 7, 10 years
A forecast of NOI
Estimate reversion value

9. Simple Formula Present value of an increasing annuity
Value= NOI1/ (discount rate- growth rate)
NOI1 is Net Operating Income (rent less expensive) during the first year of ownership
Discount rate is the required rate of return (IRR)
Growth rate is the expected growth in income
Same idea as Gordon Dividend Discount Model (see
Simple model assumes income and value will grow at the same rate forever (or until sold)

10. Example
An apartment building is expected to generate NOI of $100,00 the first year. Rents and expenses are expected to grow at 2% per year until sold after 5 years. The value of the property is expected to increase with income. Investors require a 12% rate of return. What is the value?
Value= $100,000/ (12%-2%)= $1,000,000

11. Concept of a Capitalization Rate
Capitalization rate (“cap rate”)= NOI1/ value
Ratio of first year income to value
Rearrange equation: value=NOI1/cap rate
Two ways to think about getting a cap rate:
Formula: cap rate= discount rate- growth rate e.g., in previous example, cap rate= 12%-2%= 10%
Comparable sales: cap rate=NOI1/ sale price where the sale price is from comparable properties e.g., another property sold for $1,200,000 and was expected to have NOI the first year of $120,000

12. Beyond the Simple Formula
Project the NOI for each year of a holding period
Project resale price at the end of the holding period
Discount the NOI and resale to get present value

13. Example
Income is expected to be $100,000 per year for the next 5 years due to existing leases. Starting in year 6 the income is expected to increase to $120,000 due to lease rollovers and increase at 2% per year thereafter. Investors want a 12% return. What is the value?

14. Solution First estimate resale using cap rate concept
Resale or “terminal” cap rate= 12%-2%= 10%
Apply this to income in year 6 ( first year of ownership to next owner)
Resale= ($120,000)/ .10= $1,200,000
Now discount the NOI and resale price
PMT= $100,000
FV= $1,200,000
n= 5
i= 12%
Note that the “going in cap rate” would be 100,000/ $1,041,390= 9.6%

15. NPV @12% $1,041,390 *Yr 6 NOI/ terminal cap rate of 120,000/ .10
Year 1 2 3 4 5 6
NOI
100,000
120,000
Resale
1,200,000*
Cash Flow
1,300,000
$1,041, *Yr 6 NOI/ terminal cap rate of 120,000/ .10

16. Reversion Values Expected L-T cash flows REV9= (NOI10)/ (r-g)
Directly from sales transaction data
Resale based on expected change in property values

17. Highest and Best Use Analysis
PV= NOI1/ r-g or NOI1/r
PV- BLDG cost= land value

18. Mortgage Equity Capitalization
V= M+E
DS= NOI1/ DCR
Calculate M
Calculate E (PVA + CF)
PV= M + E

19. Cap Rates and Market Conditions
Lower cap rates (higher property values)
Unanticipated increases in demand relative to supply
Higher cap rates (lower property values)
Unanticipated increases in supply relative to demand
Unanticipated increases in interest rates