Week 4 Flashcards
explain the income capitalisation approach
o Based on the theory that the current value (market value / Investment value) of a property (investment grade) is the present worth of the future income which this property is capable of producing
o Use income of the property to determine the value
The principle of “anticipation” is fundamental
o Value is a function of the anticipated benefits to be derived from the property
o This is why cash flow projections are undertaken before hand
o Value of the property = Current value of future income derived
where can income capitalisation approach be used?
Applies to income producing (investment grade) property, as well as properties that can be easily compared to income-producing properties o Offices o Retail properties o Some industrial properties o Rental residential properties etc
define a income producing / investment grade property
A property that has been purchased with the sole intention (main prupose) of earning a return on the investment either through:
o Regular rent (income)
o Capital gain
2 types of income capitalisation
Direct capitalisation yield capitalisation (DCF)
explain the DCM approach
net operating income / Capitalisation rate = Capitalised value
undertake capital adjustments where necessary
= market value of property
how to calculate NOI
potential gross income - vacancy and collection loss \+ miscellaneous income - Operating expenses - Capital expenditure = NOI
what is the capitalisation rate and how is it calculated
A rough measurement of the return on real estate investment property based on the income that the property is expected to generate
o
Measure of ratio between - produced and it’s current sale price
(NOI / MV)
o Does not include capital gains growth (therefore not accurate)
explain how:
Risk
growth in income
obsolesce
effects cap rate
risk = higher cap rate and lower value
growth in income = lower cap rate and higher value
obsolescence = shorter economic life meaning higher cap rate and lower value
explain the market extracted cap rate
o The cap rate are calculated using comparable sale evidence
o Comparable properties’ NOI and sale prices are used for the calculation
o Similar properties usually having similar cap rates = market extracted cap rate
Market cap rate = NOI / Sale price
o Direct extraction is preferred, but needs three or more comparables with good information
o Choice ultimately depends on quality of data available for each type of estimate
o Reconciliation made by weighting
define ‘capitalisation’
Is the process of converting income into value
define direct capatalisation
The process of estimating current value by dividing a single year’s (usually first year) income by a capitalization rate
capitalised value formula
Net operating income / Capitalization rate
explain capital adjustments
one off” adjustments to the value after the capitalised value has been established
o Cost items that need improvements or maintenance to ensure lettabaility
o Specific maintenance, repairs, or an essential upgrade cost or other requirement of a local authority to meet statutory regulations
o Other costs related to reletting of the space:
o Agents’ leasing fees, fit out or incentive amount and other costs to lease the space
o Capital costs of releasing
Value = Capitalized value – Capital Adjustments
benefits of DCM approach
o Simplified approach that arrives at an easily determined value
o Does not rely on projection, but on the cash flow for the upcoming 12 months
o Most useful for businesses with stable, predictable cash flows and earnings
o More appropriate for stable market conditions
disadvantages of DCM approach
o Change of future market conditions are ignored
o Fails to reflect changes in the annual cash flows from capital gain
o Inadequate data on comparable sales due to:
Above or below market leases
Differing lengths of leases
