chapter 5 book: property valuation Flashcards
what is the common way to find property valuation?
Value of property = Stabilized NOI / cap rate
why is it important to know that stabilized NOI and cap rate are just appoximations?
because the property is not always going to behave as expected
what does the actual NOI vary year after year?
because of the fluctuations between revenues and expenses
when calculating the stabilized NOI, what must you subtract from the NOI?
management fees
vacancy allowances
capital reserves
leasing costs
why consider vacancy allowances when adjusting NOI?
because you have to check history of asset
if in the past, it was a bit ratty, you have to consider it
why consider capital reserves when adjusting NOI?
you often need it for non-revenue generating capital expenditures
on-revenue generating capital expenditures
expenditures that maintain revenue stream, they don´t enhance it
ex: replacing a roof
in the cap rate valuation analysis, how should leasing costs be modeled as?
the same way as capital expenditures
lease expiration should be reviewed
expected vacancies or renewals should be listed
estimated leasing commissions or allowances should be calculated
what determines cap rates?
general economic conditions (cost and demand for capital)
perceived risks of asset class
unique attributes of a market
unique attributes of a property
how does cost and demand for capital affect cap rates?
if investors are not willing to buy properties, sellers will have to lower prices, and raise cap rates doing so
if investors are willing to buy properties, sellers will increase prices, which will then lower the cap rates
what does it mean when people say that real estate investment can be illiquid?
it takes a lot of capital to be able to get properties
this limits the number of participants
with the limited number of participants, it is not easy to find someone who will immediately be down to buy the property you’re selling
why will the same properties in different locations not have the same cap rates?
location plays a big role in cap rates and pricing
the property in the best location will have a lower cap rate, and as a result, will have higher price
which is the primary driver of cap rates in RE?
the overall strength of a market
an experienced investor will want to invent in gyu properties or challenged properties? why?
gyu properties
it presents lower risks and it is better long term
more predictable returns
what are the two basic strategies buyers of challenged assets have?
leave the challenged asset as it is
improve the asset, bringing it to a competitive level
what do market cap rates reflect?
the general economy
the perception of real estate as an asset class
the market position of an individual property
what does it take for a recent transaction to be relevant?
must have happened in market conditions similar to the ones experienced atm
ideally, it would be the same property type as well
same geographic region
can the tenant credit quality drive the cap rate? what is the assumption?
yeeeee
the tenant’s ability to pay his rent is more important than the residual value worth of the real estate
how does the discounted cash flow (DCF) method value properties?
sums the present value of its future cash flows over an investment period to its terminal value, ultimate sale value, or liquidation value
what are the three major elements in the discounted cash flow method?
the annual cash flows during the investment term
the terminal value at the end of the investment period
the discount rate used to calculate the present value of these quantities
what can affect expected cash flows
lease expirations
tenant replacements
lease-up of vacancy
operating expenses
non-revenue generating capital expenditures
expansions and renovations
what is the difference regarding expenses when we use the DCF method and stabilized NOI method?
in the latter, we consider expenses of the year that just passed
in the former, we must forecast future expenses and the changes
Future Value formula
PV * ((1+r)^t)
PV = present value r = interest t= periods
present Value formula
FV / ((1+r)^t)
FV = future value r = interest t= periods
yield curve
a graph of investment returns against time
if a yield curve is used, what must be chosen?
and index rate
the terminal value
the residual value of the property at the end of the investment period
how is the terminal value calculated?
using an estimate of the total asset value based the cap rate method
Stabilized NOI in the final year is divided by exit cap rate
exit cap rate
an estimate of the asset’s cap rate at the end of the investment period
why is it hard to estimate the terminal value?
we have to rely on assumptions involving the distant future
how do discount rates (interest rates) influence the importance of the terminal value?
the higher the discount rate and the longer the intended holding period, the lower the impact of the terminal value on overall investment value
in low interest environments, the TV is an important driver of the total DCF value
when do you set the exit cap rate? how do you set them (strategies)?
you set the exit cap rate at the beginning of the investment
if you believe market conditions are going to be gyu at time of sale, you set it higher
if you believe market conditions are going to be wack at time of sale, you set it lower
when is it more appropriate to use the DCF method?
with properties that are likely to experience a significant change in their performance over time
comparable sales method of valuing an asset
simple method of valuing real estate
comparing the property with similar ones that traded recently in similar market conditions
what are the steps of using the comparable sales method?
- market data
- common denominator
- adjustments to comparable data
what is the most common denominator to use when comparing properties?
price per unit of space
what are the steps to find adjustments to comparable data (step 3 of comparable sales method)?
- adjust for the unique location of each asset
- comparison of physical condition of each asset
- review the status of current leasing
–> all these steps create an index of comparison
- multiply unadjusted value by the comparison index
unadjusted value of asset
quantity of space X average price per measure of space
cost approach of valuing an asset
current cost of replacing the property is estimated
why use the cost approach?
you want to see how much it would cost to build a property
as an investor, you want to see if it would be worth it
when wouldn’t you use the coast approach as an investor?
when the costs of replacing a property are higher than the trading prices of the comparable properties
how do you find the value of equity?
value of asset - mark to market value of debt = value of equity
do you include debt when calculating asset value?
nah
when does debt actually lower the value of a property?
when the debt has unfavorable terms and cannot be repaid without penalty
how do investors look at return on equity?
- cash-on-cash return
2. longer term returns to equity such by using figures of merit
cash-on-cash return
the periodic cash flows available to cash invested
the current return available after paying the debt service, including principle and amortization payments
what are figures of merit?
PV
NPV
etc.
when does the debt trade at premium?
when the current balance trades above the mark to market value of interest rates
