week 4 - income cap Flashcards
explain the theory of income approach
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.
The principle of ‘anticipation’ is fundamental
Value is a function of the anticipated benefits to be derived from the property
Current Value = current value of future income derived
applications of income capitalisation approach
Applies to income-producing (investment grade) property, as well as properties that can be easily compared to income-producing properties
Offices
Retail properties
Some industrial properties
Rental residential properties etc.
define income producing property
A property that has been purchased with the sole intention of earning a return on the investment either through
Regular rent
Capital gain
income capatalisation approach can be split into
Direct cap method - profit method
DCF (yeild capatalisation)
explain the theory of direct capatalization approach
Based on the theory that the value (usually market value) of a property is based on the net operating income (NOI) produced by the property.
Is used to convert an estimate of a single year’s NOI expectancy into an indication of value by dividing the NOI by an appropriate capitalization rate
The principle of ‘anticipation’ is fundamental
Value is a function of the anticipated benefits to be derived from the property
explain the direct capatalization approach process
net operating income capatalization rate capatalized value capital adjustments = market value of property
how to calacuate Net operatin income
Potential Gross Income - Vacancy and collection loss allowance \+ Miscellaneous income - Property outgoings Net operating income
what is potential gross income
The total of all rental income (annual) derived directly from the property assuming that there is no vacancy
Lettable Area X rent per m2 per annum= Potential gross income (PGS)
Where Lettable Area could be:
- Net Lettable Area (NLA): sum of its whole floor lettable areas, office buildings and business parks. Areas excluded: stairs, fire stairs, access ways, lift shafts, smoke lobbies etc.
- Gross lettable area retail (GLAR):retail tenancy areas in shopping centres, free-standing shops, strip shops, terrace style or semi-detached shops in suburban streets.
- Gross floor area (GLA):tenancy areas in industrial property, warehouses, showrooms, and freestanding supermarkets.
define net lettable area
- Net Lettable Area (NLA): sum of its whole floor lettable areas, office buildings and business parks. Areas excluded: stairs, fire stairs, access ways, lift shafts, smoke lobbies etc
define gross lettable area retail
Gross lettable area retail (GLAR):retail tenancy areas in shopping centres, free-standing shops, strip shops, terrace style or semi-detached shops in suburban streets.
define gross floor area
tenancy areas in industrial property, warehouses, showrooms, and freestanding supermarkets.
define gross rent
Gross rent (rent in Gross Leases) – The tenant pays a flat rental amount, and the landlord pays for all property outgoings.
define net rent
Net rent (rent in Net Leases)- The tenant pays a portion or all of property outgoings in addition to rent.
define passing rent
Passing rent (Face rent): The quoted rent in the lease before taking into account any ‘Incentives’. Lease incentives: a bonus or discount offered to a tenant in consideration for their entry into a lease with a particular landlord
define effective rent
Effective rent: Face rent – lease incentives
define current market rents
Current market rents: Determined by comparison with recent new lettings of similar premises
what is vaccancy and collection allowance
Estimated income loss due to tenants vacating the property and/or tenants defaulting (not paying) their rent
Is expressed as a % of potential gross income Consider: Market conditions Historical vacancies Type of the space
what is miscellaneous income
Any income other than the rental income
Examples Naming rights Satellite dish space Communication towers Subsidy from government
explain property outgoings
Outgoings are defined as those expenses, statutory charges, fixed and variable that are paid to keep the property in a good state so as to maintain the maximum market rental capacity. Includes:
Statutory charges: land tax, municipal or shire council rates, water rates for sewerage and drainage
Operating expenses: insurance, utilities, and replacement allowance etc.
Replacement allowance- Provides for the periodic replacement of short life items.
Excludes: Financing costs, Landlord‘s and tenants’ income tax and corporation operating costs, Non-cash items (e.g. depreciation)
Outgoings recoveries (Recoverable)
- Under a net rent lease, the tenant pays the outgoings whereas under a gross rent lease the landlord is responsible for the outgoings.
- The net rent lease allows for the landlord to pay the outgoings directly (usually not directly billed to the tenant) and recover them from the tenant. This is known as recovery of outgoings (Recoverable).
what is the capatlization rate
A measure of the ratio between the net operating income (NOI) in the first year and the property’s current sale price (value)
Can be calculated by: Cap rate = NOI/ Sale price(Value)
The capitalization rate reflects the rental income-producing capacity of the property.
Used in direct cap method to calculate the value: Value= NOI/Cap rate
explain market extracted method for cap rate
Direct extraction method is preferred, and it needs three or more comparable with good information
Similar properties should have similar cap rate.The capitalization rate of subject property are calculated using comparable sale evidence
Comparable Cap Rate = NOI of comparable/ SP of comparable
Reconciliation made by weighting:
Average (weighted) of all comparable cap rates= market cap rate (cap rate of the subject property)
define capatalization
Capitalization is the process of converting income into value
define direct capatalization
Direct Capitalization is the process of estimating current value by dividing a single year’s NOI by a capitalization rate
Capitalized Value formula =
Net operating income / Capitalization rate (MV = NOI / Cap Rate)
what are capital adjustments
One-off” adjustments to the value after the capitalised value has been established
Cost items that need improvements or maintenance to ensure lettability
Specific maintenance, repairs or an essential upgrade cost, or other requirement of a local authority to meet statutory regulations
Other costs related to the reletting of the space
Agents’ leasing fees, a fitout or incentive amount, and other costs to lease the space
Capital costs of re-leasing
market value = capitalised value - capital adjustments
strengths of direct capatalisation method
: A simplified approach that arrives at an easily determined value; Does not rely on projections, only the cash flows for the upcoming 12 months; Most useful for businesses with stable, predictable cash flows and earnings; More appropriate for stable market places
weaknesses of direct capitalisation method
Change of future market condition is ignored; Fails to reflect changes in the annual cash flows; Capital Growth is ignored; Inadequate data on comparable sales due to: Above or below market leases and Differing length of leases
explain the profit method
Applied to properties whose value is derived from the profitability of the businesses.
Suitable for:
those kinds of premises with a degree of monopoly because of licensing
those which are not of a kind normally let or sold separately from the business in which they are employed
Commercial properties for which the landlord is the owner of business
Example : Hotels, Cinemas, theatres , Casinos and clubs etc.
explain the valuation process for the profit method
gross earnings
- cost of purchases (direct costs)
- working expeneses (inidrect costs)
- return on businesses owner’s capital invested divisable balance
- expected profit from business operation
money left to be paid as rent *annual rental income
market value property rental income / cap rate
exmaples of direct costs
Total cost of purchase of goods related to the main business (direct costs related to the business)
Example: For hotel properties purchases for hotel rooms, purchase costs of food and beverages etc
exmaples of working expenses
Salaries, wages Costs incurred in connection with: Utilities Printing and postage Telecommunications Advertising Repairs and maintenance etc Taxes Insurance Rates Any other costs
explain divisable balance
The Divisible Balance is the sum available to be shared between the business operation and the property.
Expected profit from business operation –a return on any capital employed and a reward to the business reflecting the extent of the risk and the need for profit.
Divisible balance-Expected profit from business operation= Rental income for the property
difference between profit and direct cap methods
Direct cap method– properties on leases with rents (e.g. gross leases and net leases).
The business is NOT to be considered.
If a building is leased to an operator to run the building as a business, the direct cap method looks purely at the rent.
Profits approach – properties owned by the business owner , direct and indivisible link between the property and the business
The business is to be considered.
Starts with the gross earnings of the business conducted at the premises that is valued.
