Ch 9 Flashcards
Specific appraisal techniques applied to develop a value indication for a property based on its earning capability and calculated by the capitalization of property income.
Income Capitalization Approach
Essentially, the income capitalization approach converts income into a lump sum indication of a property value. This can be done in one of two ways with two formulas:
- the income can be divided by a rate;
Value = Net Operating Income/ Rate
or - the income can be multiplied by a multiplier.
Value = Income X Multiplier
Gross rent is usually expressed as a x figure, while gross income is an x figure.
monthly
annualized
“A ratio of one year’s net operating income provided by an asset to the value of the asset; used to convert income into value in the application of the income capitalization approach. defines
Capitalization Rate (R)
The actual or anticipated net income that remains after all operating expenses are deducted from effective gross income but before mortgage debt service and book depreciation are deducted. defines
NOI
Net Operating Income
“A method used to convert an estimate of a single year’s income expectancy into an indication of value in one direct step, either by dividing the net income estimate by an appropriate capitalization rate or by multiplying the income estimate by an appropriate factor. Direct capitalization employs capitalization rates and multipliers extracted or developed from market data. Only one year’s income is used. Yield and value changes are implied but not explicitly identified. defines
Direct Capitalization
“The relationship between a single year’s net operating income expectancy and the total
property price or value (Ro= lo No). defines
Overall Capitalization Rate (Ro)
Overall Rate = Overall Income / Overall Value
What if the income was $48,543 and the appropriate capitalization rate was 12.4%. What is the value?
$391,476 ($48,543 /.124).
A subject property has a net operating income (NOi) of $80,000. A comparable sale sold for $525,000, and it had a verified NOi of $65,000. What is the value of the subject?
The capitalization rate (Ro)is extracted from the comparable sale as follows:
Ro= I/ V
Ro= $65,000 / $525,000
Ro = .1238 (or 12.38%)
The indicated value of the subject property based on a Ro of 12.38% is calculated as follows:
V=I/ R
V = $80,000 / 0.1238 (or 12.38%)
V = $646,203 (or $646,000 rounded)
“An amount paid for the use of land, improvements or a capital good. “ defines
Rent
“The actual rental income specified in a lease.” defines
Contract Rent
“Income due under existing leases.” defines
Scheduled Rent
“The most probable rent that a property should bring in a competitive and open market reflecting all conditions and restrictions of the lease agreement, including the rental adjustment and revaluation, permitted uses, use restrictions, expense obligations, term, concessions, renewal and purchase options, and tenant improvements (Tis).” defines
Market Rent
“Total base rent, or minimum rent stipulated in a lease, over the specified lease term minus rent concessions; the rent that is effectively paid by a tenant net of financial concessions provided by a landlord.” defines
Effective Rent
“The amount by which contract rent exceeds market rent at the time of the appraisal; created by a lease favorable to the landlord (lessor) and may reflect unusual management, unknowledgeable or unusually motivated parties, a lease execution in an earlier, stronger rental market, or an agreement of the parties. “ defines
Excess Rent
“The amount by which market rent exceeds contract rent at the time of the appraisal; created by a lease favorable to the tenant, resulting in a positive leasehold, and may reflect uninformed parties, special relationships, inferior management, a lease executed in a weaker rental market, or concessions agreed to by the parties. “ defines
Deficit Rent
“Rental income received in accordance with the terms of a percentage lease; typically derived from retail store and restaurant tenants and based on a certain percentage of their gross sales.” defines
Percentage Rent
“The periodic expenditures necessary to maintain the real estate and continue production of the effective gross income, assuming prudent and competent management. See also total operating expenses.” defines
Operating Expenses
“Operating expenses that generally do not vary with occupancy and which prudent management will pay whether the property is occupied or vacant. defines
Fixed Expenses
“Operating expenses that generally vary with the level of occupancy or the extent of services
provided. defines
Variable Expenses
Examples of Fixed Expenses
Real Estate Taxes and insurance
Examples of Variable Expenses
Management Fee
Utilities
Payroll
Decorating
Supplies
Maintenance/Repair
Trash Removal
Miscellaneous
Replacement Allowance (for everything that is typical for this business like roof, paved areas, painting, carpets, kitchen equipment, mechanicals, safety guards)
“The sum of all fixed and variable operating expenses and the replacement allowance cited
in the appraiser’s operating expense estimate.” defines
Total Operating Expenses
Formula NOI
Gross Annual Rental (Potential Gross Income, or PGI)
+ Other Income
- Vacancy/Credit Loss (V&C)
= Effective Gross Income (EGI)
- Operating Expenses (TOE)
= Net Operating Income (NOI)
“The total income attributable to property at full occupancy before vacancy and operating
expenses are deducted. “ defines
PGI
Potential Gross Income
“All income generated in the operation of the property that is not derived directly from
space rental.” defines
Other Income
“A deduction from potential gross income (PGI) made to reflect income reductions due to vacancies, tenant turnover, and nonpayment of rent; also called vacancy and credit loss or vacancy and contingency loss. “ defines
Vacancy and collection loss
“The anticipated income from all operations of the real estate after an allowance is made for vacancy and collection losses and an addition is made for any other income.” defines
Effective Gross Income = EGI
more important indicator than PGI
Some tenants may take off in the middle of the night without paying their rent =
credit loss or collection loss
A property owner of a 12-unit building does not spend any money on painting and decorating over a three-year period, and therefore includes no expenses for painting and decorating on his operating expense sheet that he provides to the appraiser. What should the appraiser do?
Calculate the expenses for painting and decorating and include them in the appraisal.
Which Expenses should not be included in the Operating expenses?
Income Taxes
Depreciation
Financing & Debt Service
Capital Improvements
“A method used to convert future benefits into present value by
1)discounting each future benefit at an appropriate yield rate, or
2) developing an overall rate that explicitly reflects the investment’s income pattern, holding period, value change, and yield rate.” defines
Yield Capitalization
Difference between Yield Capitalization and Direct Capitalization
Direct capitalization is a “snapshot”, i.e., a single-year’s income was converted into an indication of value.
Yield capitalization takes into account the income over a holding period, which could be several years in duration.
