class 4 pp: Real Estate Valuation

Question 1

What are the 3 main types of Real Estate Valuation

Answer 1

Income Approach

Comparable Sales Approach

Cost Approach

Question 2

two types of income approach

Answer 2

Capitalized NOI

Discounted Cash Flow

Question 3

The most widely used method to estimate the value of a commercial property

Answer 3

the Capitalized NOI approach

Question 4

the Capitalized NOI approach formula

Answer 4

stabilized NOI / cap rate

= value of property

Question 5

the Capitalized NOI approach theory

Answer 5

valuation method presumes that a property will generate its stabilized NOI in perpetuity

The value and cap rate are an inverse relationship

Question 6

in the Capitalized NOI approach, what does it mean when we say that the value and cap rate are an inverse relationship?

Answer 6

The higher the cap rate the lower the value

and vice versa

Question 7

what are the steps to find the Stabilized NOI?

Answer 7

1. find effective rental income
2. find the gross operating income
3. find the stabilized NOI

Question 8

how do you find effective rental income?

Answer 8

potential rental income - vacancy and credit allowance

Question 9

vacancy and credit allowance

Answer 9

You need to find what’s the average vacancy for similar properties

Credit allowance:
All the money that you won’t get directement

Question 10

potential rental income

Answer 10

all types of rent included assuming 100% full, no vacancy

the sum of all rents (including expense participation) under the terms of each lease

Question 11

how do you find gross operating income?

Answer 11

effective rental income + other miscellaneous income

Question 12

how do you find stabilized NOI

Answer 12

Gross operating Income - operating expense

Question 13

how do you find potential rental income if property is not 100% occupied?

Answer 13

a market-based rent is used based on lease rates and terms of comparable properties

Question 14

Vacancy and Credit Losses

Answer 14

income lost due to tenants vacating the property and/or tenants defaulting (not paying) their lease payments

Question 15

how can one determine Vacancy and Credit Losses ?

Answer 15

A historical average or a specific analysis

Question 16

other miscellaneous income

Answer 16

income other than rent derived from the space tenants occupy

Question 17

operating expenses

Answer 17

all expenditures required to operate the property and command market rents

Question 18

exclusions from NOI

Answer 18

debt service

depreciation

income taxes

tenant improvements

sometimes, leasing commissions

Question 19

debt service

Answer 19

Financing costs are specific to the owner/investor and as such are not included in calculating NOI

Question 20

depreciation

Answer 20

Depreciation is not an actual cash outflow, but rather an accounting entry

therefore, not included in the NOI calculation

Question 21

income taxes

Answer 21

Since income taxes are specific to the owner/investor they are also excluded from the net operating income calculation

Question 22

tenant improvements

Answer 22

construction within a tenant’susable spaceto make the space viable for the tenant’s specific use

Question 23

leasing commissions

Answer 23

the fees paid to real estate agents/brokers involved in leasing the space

Question 24

capitale expenditures

Answer 24

expenses that occur irregularly for major repairs and replacements

usually funded by a reserve for replacement

Question 25

what are the NOI adjustments to make

Answer 25

usually includes management fees sometimes, recurring non-revenue generating capital expenditures and leasing commission

Question 26

what does it mean if no management fees are reported?

Answer 26

the seller is usually the one doing management himself property management costs are under reported

Question 27

what do you do when there no management fees reported?

Answer 27

you estimate them by looking at market how much management costs are for similar properties in similar conditions

Question 28

capitalization rates

Answer 28

can be viewed as the annual return that an investor will get

Question 29

what are some determinants for cap rates?

Answer 29

Other investment yields (especially GOC rate) Perceived risk of asset class The market Property characteristics

Question 30

risk premium

Answer 30

the additional risk an investor gets from investing in a certain asset because he wants to obtain higher returns

Question 31

what composes a property's characteristics?

Answer 31

Type (retail, office, hotel, etc) Quality Size Quality of the rent roll

Question 32

when will cap rates on similar properties sold be examined and adjusted for the factors listed?

Answer 32

In determining the cap rate for a particular property

Question 33

where can cap rate from recent transactions be obtained?

Answer 33

from third party service firms

Question 34

discounted cash flow (DCF)

Answer 34

values a property by adding together the present value of its future cash flows including its Terminal Value

Question 35

terminal value (TV)

Answer 35

the value of the property at the end of the investment period calculated based on the NOI at that time

Question 36

how do you find value of property using DCF?

Answer 36

1. Calculate all individual NOI of the next 5 years 2. Calculate all individual cash flows for 5 years 3. Calculate the expected NOI for year 6 4. Calculate terminal value at end of year 5 5. Find present value of the terminal value

Question 37

discount rate used on DCF?

Answer 37

should reflect the rate of return required by an investor for an investment with this level of risk

Question 38

can a discount rate for TV be different than discount rate for cash flows in the DCF method? if so, on which condition?

Answer 38

yeee if the condition of the property is expected to change

Question 39

The Comparable Sales Approach

Answer 39

estimates the value of a property by comparing it with the recent selling price of properties that have similar characteristics

Question 40

for which type of property is the Comparable Sales Approach most often used?

Answer 40

single family houses

Question 41

Comparable sales should be for properties of the same or similar...

Answer 41

Type Location Age Condition

Question 42

How does the Comparable Sales Approach work?

Answer 42

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

Question 43

The Cost or Replacement Cost Approach

Answer 43

estimates the current cost of replacing the subject property using industry sourced construction cost data

Question 44

how is the Cost or Replacement Cost Approach useful for investors?

Answer 44

informs the investor of the likelihood of new properties being developed