Module 7 Flashcards
During the sales comparison approach, what is investigated?
Similar buildings and per-square-foot value
When is the sales comparison approach valuable?
When there are many similar buildings to compare
What is the most valuable way to value properties?
Income-based approach
What is done during the income-based approach?
Analyze a set of cash flows to return a value
What is done in a discounted cash flow model?
Look at the cash flows to find the net present value
What are the three ways to approach real estate valuation?
Cost approach, sales comparison approach, and income-based approach
What is the cost approach to real estate valuation?
Looks at the cost of land plus construction costs while excluding depreciation
What are the types of depreciation associated with the cost approach to real estate valuation?
Physical deterioration, functional obsolescence, and external obsolescence
What is physical deterioration?
Decay
What is functional obsolescence?
Problems with style and design
What is external obsolescence?
A neighborhood mismatch
When is the cost approach to valuation used?
With properties lacking income or similar transactions
What are the main problems with the sales comparison approach?
Lack of similar transactions, difficulty in assigning dollar values to attributes, unobserved heterogeneity
What is unobserved heterogeneity?
Acknowledging that all differences may not be readily observed
When is the sales comparison approach commonly used?
With residential properties
What is net operating income in real estate?
The income properties yield after subtracting vacancy and expenditures
What are the two income-based approaches?
Discounted cash flow and direct capitalization
What is the process for direct capitalization?
Estimate the NOI of the cash flow for the first period, then compare the NOI to those of your neighbors, and then get a rate of return from there
What is potential gross income?
The expected income if the entire building is occupied (aka no vacancy)
What is market rent?
Renting when a lease is new
What is contract rent?
Renting from existing leases
What are the main types of leases?
Flat, step-up/escalated, indexed, and percentage
What is a flat lease?
A lease with equal rent over the duration of the lease
What is a step-up/escalated lease?
A lease with predetermined increases in rent during the lease
What is an indexed lease?
A lease where rent increases based on inflation or consumer price index
What is a percentage lease?
A lease that is structured with a base rent plus a percentage of revenue/profit
How does occupancy affect valuation?
It has an impact on Net operating income. If there is a large amount of vacancy then the PGI will be low which lowers the cash flow.
What are common lease terms?
Concessions by landlord, tenant renewal options, leasing commissions, cost recoveries
What is an example of concessions of a landlord regarding free rent?
If you come now then you get free rent for a year. This is because the owner knows once the occupants are there it will be hard for them to leave so there will be long periods of future expected cash flows
What is an example of concessions by a landlord regarding improvements?
Ask what the tenant wants for improvements (these can be paid by tenants or owners). These improvements will then persuade the occupants to come.
What are tenant renewal options?
Define when you will have to discuss renewal can be 3 to 5 years
What are the two types of leasing terms in the United States for housing?
Month-to-month lease, and annual lease
What do leasing commissions say?
Tenants and owners may have their own brokers
What are the two areas of cost recovery?
Operating expenses and common area maintenance
What is common area maintenance?
It defines the common area of the building and determines who has to pay for them
When calculating effective gross income what do you do?
Start with potential gross income - vacancy & collection losses + miscellaneous income
What percentages are typically used for vacancy and collection losses?
5-10%
What is a strategy for determining vacancy if you do not use the standard percentage?
Use comparables on the market to find the vacancy rates of similar property types
What are the two types of operating expenses?
Fixed and variable
What are fixed operating expenses?
Expenses not dependent on the property
What is an example of a fixed operating expense?
Property taxes
What are examples of variable operating expenses?
Utilities, ordinary maintenance, common area maintenance, security
Tenants responsibility for operating expenses can vary from a _ lease to a _ lease
Gross, Triple Net
What happens during a gross lease?
The tenant does not pay any operating expenses
What happens during a net lease?
The tenant pays for the property taxes
What happens during a net-net lease?
The tenant pays for the property taxes and insurance
What happens during a triple-net lease?
The tenant pays for all operating expenses
What are capital expenditures?
Non-recurring expenses that lead to an increase in the value of the property
What are examples of capital expenditures?
Replacing the roof or mechanical systems (HVAC) and other tenant improvements
Capital expenditures can be funded through _
Reserve accounts
What are reserve accounts?
Accounts that collect annual payments where savings build up to pay for expenses that are expected in the future
What are the categories used to define the condition/potential of the property?
Classes A through C
What is the description of a class A property?
In the best location, is very high quality, and is built to last
What is the description of a class B property?
An older building that is in a good location
What is the description of a class C property?
Run-down properties
What is an example of a class C property?
Strip malls
How is the cap rate calculated?
Net operating income you can get next period / what you have to pay for it
Why does a cap rate typically drop?
An increase in prices
Which category has higher cap rates? Class A or Class B?
Class B because the selling price for Class B is lower than the selling price for Class A
What are the main types of commercial real estate?
Office, retail, hospitality, industrial, recreational, institutional, multifamily
What are examples of institutional real estate?
Hospitals and prisons
Why is the sales-comparison approach to valuation common for residential real estate but not commercial real estate?
There are many properties to compare in residential real estate, but not many in commercial real estate
_ should be lower than _ for projects that you want to invest in
MIRR, IRR
Why do you want MIRR to be lower?
IRR assumes that you are reinvesting your cash flows at the same rate of return as your project. The alternative rate of return will be lower than the return of your project and that is what you will actually be reinvesting your cash flows into
The finance rate of _ cash flows will not change the _ when there are no negative cash flows in the future
Negative, MIRR
What does IRR assume about cash flows?
That they are reinvested at the same rate as IRR
What does MIRR assume about positive cash flows?
That they are reinvested at the cost of capital
When do CAP rates increase in unanticipated markets?
When there is an increase in supply/demand or interest rates
When do CAP rates decrease in unanticipated markets?
When there is a decrease in supply/demand or interest rates
What is Cash-on-cash (COC)?
The measure of first-year cash flow as a ratio of upfront developer equity
What does the COC calculation ignore?
Income taxes, Loan amortization, and terminal cap rates
What is the Internal Rate of Return?
The calculation of interest-rate when the net present value of all cash flows equals zero
What are the assumptions with IRR?
All positive cash flows are reinvested and all negative cash flows are borrowed at the same interest rate the property itself generates
How is Net Present Value (NPV) calculated?
Subtract the present value of costs from the present value of benefits of making a decision today
What are the key assumptions of Net Present Value?
The opportunity cost of equity is often unclear and ignores a potential value in delaying the decision until more info is available
What are the three ways to estimate net sales proceeds?
Buyer assumes a constant rate of appreciation, Buyers conduct DCF analysis, Buyers conduct Direct CAP analysis
