Part 5 Income Analysis Flashcards
The appraisal of income producing property is based on
the capitalization process, also known as the conversion of income into value.
Most income producing properties are valued based on their ability to produce
net operating income.
Gross income after vacancy and operating expenses are subtracted.
Net operating income
What the appraiser anticipates will be the next 12 months income expectations and expense forecasts. The next 12 months begins on the effective date of value.
Reconstructed operating statement
_____ is where you will often begin the income cap approach.
lease analysis
_____ lease. The landlord pays all of the operating expenses.
Gross lease
The tenant pays all of the operating expenses.
Net Lease
The term absolute net least or triple net lease may be used to describe a lease in which
the tenant pays all of the operating expenses.
The actual rental income specified in a lease.
Contract rent
Income due under existing leases.
scheduled rent
Note:
Contract and scheduled rent are often the same; however, there are
situations where they differ. For example, a one-year lease might indicate a
monthly contract rent of $1,200, but the tenant is given one month of free
rent as an inducement. Therefore, assuming the free rent was amortized over
the term, the monthly scheduled rent (as well as the effective rent) is $1,100.
When calculating scheduled rent, adjust for rent concessions, discounts, or
other benefits that induce a prospective tenant to enter into a lease.
The most probable rent that a property should bring in a competitive market.
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
Total rent to be paid over the lease term minus concessions.
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 or unusually motivated
parties, special relationships, inferior management, a lease executed in a
weaker rental market, or concessions agreed to by the parties.
Deficit rent
Market rent is higher than what the property is rented for.
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. Due to the higher risk inherent in
the receipt of excess rent, it may be calculated separately and capitalized at
a higher rate in the income capitalization approach.
Excess rent
When the landlord is charging more for rent then the market 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
retail stores paying a percentage of their gross sales.
The percentage rent paid over and above the guaranteed
minimum rent or base rent; calculated as a percentage of sales in excess
Appraisal Institute Basic Appraisal Procedures Part 5 – 83
of a specified breakpoint sales volume. This is not excess rent, but is a
contract rent.
Overage rent
amount paid above the minimum rent, a percentage of sales above a breakpoint
Procedures for rent analysis
a. Study present rent schedule.
b. interview tenants to verify
c. Study rents of comp properties. (need at least 3 years if possible)
d. Adjust comp rents
e. Estimate rent for subject property.
What are the differences between a rent analysis for fee simple interest and a rent analysis for a leased fee(landlord’s) interest?
Fee simple interest would be based on the market rent the property is capable of achieving.
Rent analysis for leased fee (landlord’s) interest would be based on existing contract rent and market rent for vacant and owner occupied space.
The first step in analyzing a property’s earning power is to analyze
NOI expectancy
Past and current incomes are important, but the future is critical.
Where do you get operating expense data of properties?
- actual operating history of the subject and comps
- published resources such as (IREM) Institute of Real Estate Management
and
(BOMA) Building Owners and Managers Association
This is the total rent possible if the property is 100% occupied.
Potential gross income
PGI
A reconstructed operating statement starts with
Potential gross income
What is lag vacancy?
units rented at below-market rates
The periodic expenditures necessary to maintain the real estate and continue production of the effective gross income.
Operating expenses
Expenses normally break down into what three groups?
- Fixed expenses
- Variable expenses
- Replacement allowance
_____ operating expense generally do not vary with occupancy, management will pay whether the property is occupied or not.
Fixed expenses
taxes, insurance
____ are operating expenses vary with level of occupancy
variable
examples: management charges, utilities, and maintenance and repairs
Leasing fee, heat, payroll, cleaning, decorating, grounds maintenance
_____ is an allowance that provides for the periodic future replacement of short-lived building components that wear out.
Replacement allowance
roof, carpet, driveways, boilers
True or False
An operating statement for appraisal purposes might differ from a statement prepared by an owner or an accountant.
True
When all fixed and variable operating expense are added together with the replacement allowance, this sum is referred to as the
total operating expenses (OE)
Potential gross income = $ 125,000 PGI
Vacancy/collection losses (minus) − − 5,000
Effective gross income = 120,000 EGI
Operating expenses (minus) − − 54,000 OE
Net operating income = $ 66,000 IO
Debt service (minus) − −
Pretax cash flow
example
The net income that remains after operating expenses are deducted from effective gross income.
‘
Before mortgage debt service and book depreciation are deducted.
Net operating income
*may be calculated before or after deducting the replacement allowance.
The payment for principle and interest of mortgage debt.
Mortgage debt service
The portion of net operating income that remains after
mortgage debt service
but before
Income tax
Ratio of operating expense to effective gross income
Operating expense ratio (OER)
the complement of net income ratio, i.e., OER = 1-NIR
The ratio of net operating income to effective gross income (NOI/EGI)
NIR (Net income ratio)
NIR = 1 -OER
Ratio of net operating income to annual debt service
(DCR) Debt coverage ratio
measures ability of a property to meet its debt service out of net operating income
*assist in identifying operating statements that deviate from typical patterns
Bothe the Operating expense ration (OER) and the Net income ratio (NIR) is applied against the Effective Gross income (EGI).
Since NIR and OER and complements, they will always add up to 1. In the example, 45% OER + 55% NIR = 1
Who would want to know the debt coverage ratio?
Lenders
it’s generally greater than 1.0
The riskier the property, the higher they want the DCR to be.
What are excluded items from an appraisers reconstructed operating statement?
Book depreciation income tax special corporation costs non-business travel additions to capital Expenditures for capital improvements (such as a new roof) that do not recur every year
Which of the following best describes a net lease?
the tenant pays all operating expenses
In a net lease, the tenant pays all operating expenses. This is commonly found in single-tenant retail properties.
Which type of lease is based on the business activity of the tenant?
A percentage lease is based on rent, or some portion of the rent, connected to a specified percentage of the business volume, productivity, or use.
A multi-unit apartment building has an effective gross income of $555,666. The fixed expenses are $111,000 and variable expenses are $125,898. What is the operating expense ratio (OER)?
42.63%
To calculate the operating expense ratio (OER), we must add the fixed and variable expenses together, which results in $236,898. Taking the total operating expenses and dividing by effective gross income (EGI) gives us the OER. $236,898 / $555,666 = 0.4263, or 42.63%.
A property has a potential gross income of $600,000. Vacancy and collection loss are estimated at 10% in the market, and operating expenses total $250,000. What is the net operating income (NOI)?
$290,000
Recall that potential gross income (PGI) minus vacancy = effective gross income (EGI) minus operating expenses (OE) = net operating income (NOI). So, in this case, $600,000 x 0.90 = 540,000 - 250,000 = $290,000.
If the property to be appraised has been recently leased and all the lease terms are available, would the appraiser still need to estimate market rent?
Yes, it is necessary to determine whether the contract rent is above or below market rent.
The contract rent may differ from comparable rents found in the market for a variety of reasons.
The distinction between fixed and variable expenses is made based on
occupancy.
The distinction between fixed and variable expenses is made based on occupancy.
A multi-unit apartment building has a net operating income of $505,000 and an operating expense ratio (OER) of 43.56%. The vacancy is estimated at 4% in the market. What is the net income ratio (NIR)?
56.44%
The net income ratio (NIR) can be calculated by taking the complement of the operating expense ratio. In this case, 1- 0.4356 = 0.5644, or 56.44%
A warehouse has a net operating income of $135,000 and a net income ratio (NIR) of 60%. The vacancy is estimated at 4% in the market. What is the operating expense ratio (OER)?
40%
The operating expense ratio (OER) can be calculated by taking the complement of the net income ratio. In this case, 1 - 0.60 = 0.40, or 40%.
Which of the following is necessary to calculate net operating income?
subtracting operating expenses from effective gross income
When operating expenses are deducted from effective gross income, the result is net operating income.
PGI minus allowance for vacancy and collection loss?
Effective gross income
EGI minus operating expenses
Net operating income
Net income minus debt service
Pretax cash flow
A contract calling for changes in the amount of rent at one or more points during the lease term
Graduated rental lease
A lease in which some of the rent is based on the volume of business
Percentage lease
The actual rent specified in a lease
Contract rent
The amount by which contract rent exceeds market rent
Excess rent
Percentage rent paid over and above the base rent
Overage rent
Ratio of net operating income to annual debt service
Debt coverage ratio
Ratio of operating expenses to effective gross income
Operating expense ratio
Operating expense ratio (OER). The ratio of total operating expenses to
effective gross income (TOE/EGI); the complement of the net income ratio, i.e.,
OER = 1 − NIR.
$54,000 OE / $120,000 EGI = 0.45 OER (1 − 0.55 NIR)
Net income ratio (NIR). The ratio of net operating income to effective gross
income (NOI/EGI); the complement of the operating expense ratio, i.e.,
NIR = 1 − OER.
$66,000 NOI / $120,000 EGI = 0.55 NIR (1 − 0.45 OER)
