Powerpoint class 5

Question 1

three approaches to Real Estate appraisals

Answer 1

Cost approach

Sales comparison approach

Income approach

Question 2

Cost approach

Answer 2

Buyer would not pay more for a property than it would cost to purchase land and construct a comparable building

Question 3

Sales comparison approach

Answer 3

Buyer would not pay more for a property than others are paying for similar properties

Question 4

Income approach

Answer 4

Value is based on the expected rate of return required by a buyer to invest in the subject property

Value = present value of anticipated income

Often called “income capitalization”

–> Capitalize: to convert future income into a present value

Question 5

the two income approach methods

Answer 5

Direct Capitalization Method

Discounted Cash Flow Method

Question 6

Direct Capitalization Method

Answer 6

Value is based on capitalizing the first year NOI of the property using a capitalization rate

Similar in spirit to valuing a stock using a price/earnings multiple

Question 7

Discounted Cash Flow Method

Answer 7

Value is based on the present value of the property’s future cash flows using an appropriate discount rate

Project net CFs for a standard holding period (say, 10 yrs)

Discount all expected future CFs at required return (IRR)

Question 8

DCF valuation models require:

Answer 8

1. estimate of typical buyer’s expected holding period
2. estimates of net (annual) CFs over expected holding period, including net income from expected sale of property
3. appraiser to select discount rate (required IRR)

Question 9

NOI formula (for Real Estate)

Answer 9

Potential Gross Income
- Vacancy and Collection Loss
+ Miscellaneous Income

= Effective Gross Income

• Operating Expenses
• Capital Expenditures

= NOI

Question 10

Potential gross income:

Answer 10

Rental income assuming 100% occupancy

Sometimes referred to as potential gross revenue (PGR)

Contract rent from in-place leases
+
Rent that could be collected on vacant space if it were leased at current market rental rates

Question 11

VC-vacancy & collection loss is based on:

Answer 11

Historical experience of subject property

Competing properties in the market

“Natural vacancy” rate

Question 12

“Natural vacancy” rate

Answer 12

Vacancy rate that is expected in a stable or equilibrium market

Question 13

Miscellaneous income

Answer 13

Garage rentals & parking fees (office)

Laundry & vending machines (apts., office)

Clubhouse rentals (apts.)

Question 14

Operating Expenses

Answer 14

Ordinary & regular expenditures necessary to keep a property functioning competitively

Question 15

fixed operating expenses

Answer 15

Expenses that do not vary with occupancy (at least in the short-run)

ex: hazard insurance and local property taxes

Question 16

Variable operating expenses

Answer 16

Expenses that tend to vary with occupancy

ex: Utilities and Maintenance & supplies

Question 17

Operating Expenses do not include:

Answer 17

Mortgage payments

Tax depreciation

Capital expenditures

Leasing commissions

Question 18

How do most appraisers treat Capital Expenditures (CAPX) when calculating cash flow and NOI?

Answer 18

Treat it as the “above line”

Above Line
     EGI
  -  OE
  -  CAPX
  =  NOI

Question 19

How do institutional investors treat Capital Expenditures (CAPX) when calculating cash flow and NOI?

Answer 19

as the “below line expense”

EGI
  -  OE
 =  NOI                 
   - CAPX
 =  Net Cash Flow

Question 20

Income Approach: Direct Capitalization

Answer 20

Value = NOI (first year) / cap rate

Direct capitalization only uses first year NOI, but Ro reflects all future cash flows:

–> Transaction prices of the comparable reflect the value of future cash flows.

–> Cap rates extracted from these sale transactions reflect the value of future cash flows as well.

Question 21

Effective Gross Income Multiplier (EGIM)

Answer 21

EGIM = sale price ÷ effective gross income

Quick indicator of value for smaller rental properties

Requires no operating expense information

Question 22

Effective Gross Income

Answer 22

Potential gross income
– Vacancy and collection loss
+ Miscellaneous income

Question 23

Effective Gross Income Multiplier (EGIM) (critical assumptions)

Answer 23

Roughly equal operating expense percentages across subject & comparable properties

Assumes market rents are paid

Question 24

when is the Effective Gross Income Multiplier (EGIM) best used?

Answer 24

Best used for properties with short-term leases (apartments & rental houses)

Question 25

how do you find the value of a property using the EGIM

Answer 25

Average EGIM * Effective Gross Income

Question 26

Issues with the Direct Capitalization Method

Answer 26

Inadequate data on comparable sales due to:

–> Above- or below-market leases

–> Differing length of leases & rent escalations

–> Differing distributions of operating expenses between landlord and tenant