Chapter 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
This approach converts income into a lump sum indication of a property value. This can be done in one of two ways:
the income can be divided by a rate; or
the income can be multiplied by a multiplier.
Income capitalization approach
Value = Income / Rate Value = Income X Multiplier
These are:
Income Capitalization formulas
Let’s suppose we have a property that produces an income stream of $10,000. Let’s multiply that by 8. What do you get?
Now take that same $10,000 and divide it by 1/8 or .125. What do you get?
80,000 and 80,000
Take $10,000 and multiply by 10 and then divide $10,000 by 1/10 or .10. Pick any number. Multiply $10,000 by 6 or divide by 1/6. It always works out the same.
When appraising small residential income properties, we typically use a
multiplier
Most of the time, when utilizing multipliers we are using _________________ to arrive at an indication of value
Gross rent or income to
Gross rent is usually expressed as a
monthly figure
Gross income is an
annualized figure
Gross income is simply the total of the ____________ plus any other income from the property operationg
rents for the whole year
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
Capitalization Rate
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. Note: This definition mirrors the convention used in corporate finance and business valuation for EBITDA (earnings before interest, taxes, depreciation, and amortization)
Net Operating Income (NOI)
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.
Direct Capitalization
What if the income was $48,543 and the appropriate capitalization rate was 12.4%?
You would need your calculator to ascertain that the indicated value was $391,476 ($48,543 /.124).
The relationship between a single year’s net operating income expectancy and the total property price or value (RO = IO /VO)
Overall Capitalization Rate (Ro)
An amount paid for the use of land, improvements or a capital good.
Rent
The actual rental income specified in a lease
Contract Rent
Income due under existing leases
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)
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
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.
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.
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
Percentage Rent
"A ratio of one year’s net operating income provided by an asset to the value of the asset" is the definition of interest rate mortgage rate capitalization rate prime rate
Capitalization Rent
Converting an estimate of a single year's expected income into an indication of value is yield approach direct capitalization cost approach adjustment process
Direct Capitalization
The formula for applying the income capitalization approach is value = rate / income value = income / rate value = income + rate value = rate - income + expenses
value = income / rate
"The actual rental income specified in a lease" is the definition of overage rent contract rent market rent excess rent
Contract 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
Operating Expenses
Expenses are divided into two categories
Fixed Expenses
Variable Expenses
Operating expenses that generally do not vary with occupancy and which prudent management will pay whether the property is occupied or vacant.
Fixed Expenses
Operating expenses that generally vary with the level of occupancy or the extent of services provided
Variable Expenses
This type of variable expense varies, depending on your market and usually is based on a percentage of the gross income.
Management Fee
Consideration should be given to salaries paid to employees involved in the operation of the property.
Payroll
The cost of updating interior decor and finishes should be considered.
Decorating
Typically these are miscellaneous materials not covered by other categories.
Supplies
This category applies to landlord expenses for upkeep of the property, both interior and exterior, and includes such items as roof repair, parking, sidewalk repair, window repair, electrical or plumbing repair, and maintenance of grounds or a swimming pool.
Maintenance
This may often be the expense of the tenant, and leases should be reviewed to see to whom this expense applies. It may be a municipal service or a private service. In some commercial and industrial operations, this may be a significant expense - to get rid of cardboard and packing materials, excess raw materials used in production, or perhaps the need to dispose of hazardous waste materials.
Trash Removal
This expense allows for the replacement of building components that may still have a remaining economic life, but will need replacement prior to the end of the remaining economic life of the building. You must determine the effective or actual age of a component and the estimated remaining life of the component
Replacement Allowance
The sum of all fixed and variable operating expenses and the replacement allowance cited in the appraiser’s operating expense estimate
Total Operating Expenses
Gross is what you _______with - Net is what is _____ ______!
start; left over
The total income attributable to property at full occupancy before vacancy and operating expenses are deducted
Potential gross income
All income generated in the operation of the property that is not derived directly from space rental. This could include income from vending machines, coin-operated washers and dryers, income from storage or parking spaces, etc.
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
Vacancy and collection loss
This type of income is a more important indicator than potential gross income
Effective gross income
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
Effective Gross Income
There is a difference between operating expenses and expenses used in accounting. Here are a few examples:
Income Taxes
Depreciation
Financing and debt service
Capital Improvements
To find net operating income, we perform the following steps:
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)
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
Yield Capitalization
The yield rate must provide for both the return __ and the return __ capital.
on; of
The return __ investment will come from periodic cash flows that result from net income from rentals.
on
The return __ the investment may come from the rents, other income, the reversion when the property is sold at the end of the holding period, or any combination thereof.
of
With this method, you must draw specific conclusions about changes in net income, cash flow, and property value over the holding period. You must interpret market trends and investor expectations to come up with a market-oriented discount rate.
Yield capitalization
Which of these would be considered an operating expense? financing costs management fee depreciation income taxes
Management Fee
Which type of expenses do not vary with the occupancy of the property?
variable expenses
reserves for replacement
fixed expenses
Fixed Expenses
The primary difference between direct capitalization and yield capitalization is
yield capitalization uses rates that are not extracted from the market
direct capitalization uses one year’s income; yield capitalization uses several years income
yield capitalization is used for properties that are not primarily income-producing
there is no difference; the terms are synonymous
direct capitalization uses one year’s income; yield capitalization uses several years income
Which of these would be a fixed expense? maintenance management fee property taxes utilities
Property taxes
“The total income attributable to real property at full occupancy before vacancy and operating expenses are deducted” is the definition of
effective gross income
net operating income
potential gross income
operating income
potential gross income
All of the following are variable expenses, EXCEPT for
payroll
insurance
utilities
management
insurance
A 32 unit apartment building has 12 units rented at $900 per month, 12 units rented at $1,100, and 8 units rented at $1,300 per month. What is its gross income?
$14,400
$87,200
$412,800
$456,900
412,800
\_\_\_\_\_\_\_\_\_\_\_\_\_ rent is defined as ”the actual rental income specified in a lease.” Contract Market Effective Deficit
Contract
Which term is defined as: "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"? Capital Effective gross income Net income Net operating income
Net Operating Income
The basic formula for income capitalization states that value equals \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_ divided by a \_\_\_\_\_\_\_\_\_\_. gross income, rate income, multiplier rate, income income, rate
income,rate
A 12 unit apartment building has 6 units rented at $900 per month and 6 units rented at $1,050 per month. What is its gross income?
$1,950
$23,400
$86,500
$140,400
$140,400
____________ expenses are “operating expenses that generally do not vary with occupancy.”
Fixed
Variable
Unvarying
Insurance
fixed
