class 4 pp: Real Estate Valuation Flashcards
What are the 3 main types of Real Estate Valuation
Income Approach
Comparable Sales Approach
Cost Approach
two types of income approach
Capitalized NOI
Discounted Cash Flow
The most widely used method to estimate the value of a commercial property
the Capitalized NOI approach
the Capitalized NOI approach formula
stabilized NOI / cap rate
= value of property
the Capitalized NOI approach theory
valuation method presumes that a property will generate its stabilized NOI in perpetuity
The value and cap rate are an inverse relationship
in the Capitalized NOI approach, what does it mean when we say that the value and cap rate are an inverse relationship?
The higher the cap rate the lower the value
and vice versa
what are the steps to find the Stabilized NOI?
- find effective rental income
- find the gross operating income
- find the stabilized NOI
how do you find effective rental income?
potential rental income - vacancy and credit allowance
vacancy and credit allowance
You need to find what’s the average vacancy for similar properties
Credit allowance:
All the money that you won’t get directement
potential rental income
all types of rent included assuming 100% full, no vacancy
the sum of all rents (including expense participation) under the terms of each lease
how do you find gross operating income?
effective rental income + other miscellaneous income
how do you find stabilized NOI
Gross operating Income - operating expense
how do you find potential rental income if property is not 100% occupied?
a market-based rent is used based on lease rates and terms of comparable properties
Vacancy and Credit Losses
income lost due to tenants vacating the property and/or tenants defaulting (not paying) their lease payments
how can one determine Vacancy and Credit Losses ?
A historical average or a specific analysis
other miscellaneous income
income other than rent derived from the space tenants occupy
operating expenses
all expenditures required to operate the property and command market rents
exclusions from NOI
debt service
depreciation
income taxes
tenant improvements
sometimes, leasing commissions
debt service
Financing costs are specific to the owner/investor and as such are not included in calculating NOI
depreciation
Depreciation is not an actual cash outflow, but rather an accounting entry
therefore, not included in the NOI calculation
income taxes
Since income taxes are specific to the owner/investor they are also excluded from the net operating income calculation
tenant improvements
construction within a tenant’susable spaceto make the space viable for the tenant’s specific use
leasing commissions
the fees paid to real estate agents/brokers involved in leasing the space
capitale expenditures
expenses that occur irregularly for major repairs and replacements
usually funded by a reserve for replacement
what are the NOI adjustments to make
usually includes management fees
sometimes, recurring non-revenue generating capital expenditures and leasing commission
what does it mean if no management fees are reported?
the seller is usually the one doing management himself
property management costs are under reported
what do you do when there no management fees reported?
you estimate them by looking at market how much management costs are for similar properties in similar conditions
capitalization rates
can be viewed as the annual return that an investor will get
what are some determinants for cap rates?
Other investment yields (especially GOC rate)
Perceived risk of asset class
The market
Property characteristics
risk premium
the additional risk an investor gets from investing in a certain asset because he wants to obtain higher returns
what composes a property’s characteristics?
Type (retail, office, hotel, etc)
Quality
Size
Quality of the rent roll
when will cap rates on similar properties sold be examined and adjusted for the factors listed?
In determining the cap rate for a particular property
where can cap rate from recent transactions be obtained?
from third party service firms
discounted cash flow (DCF)
values a property by adding together the present value of its future cash flows including its Terminal Value
terminal value (TV)
the value of the property at the end of the investment period
calculated based on the NOI at that time
how do you find value of property using DCF?
- Calculate all individual NOI of the next 5 years
- Calculate all individual cash flows for 5 years
- Calculate the expected NOI for year 6
- Calculate terminal value at end of year 5
- Find present value of the terminal value
discount rate used on DCF?
should reflect the rate of return required by an investor for an investment with this level of risk
can a discount rate for TV be different than discount rate for cash flows in the DCF method? if so, on which condition?
yeee
if the condition of the property is expected to change
The Comparable Sales Approach
estimates the value of a property by comparing it with the recent selling price of properties that have similar characteristics
for which type of property is the Comparable Sales Approach most often used?
single family houses
Comparable sales should be for properties of the same or similar…
Type
Location
Age
Condition
How does the Comparable Sales Approach work?
data from the comparable sales is converted to some common factor
–> doors, square feet or units
The appraiser must then use judgement to determine the value after considering the different characteristics (condition, age, location, etc.) of the properties
The Cost or Replacement Cost Approach
estimates the current cost of replacing the subject property using industry sourced construction cost data
how is the Cost or Replacement Cost Approach useful for investors?
informs the investor of the likelihood of new properties being developed
