590 8
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This document discusses methods for estimating the income and expenses of a real estate property to determine its value. It describes how to calculate potential gross income, vacancy and credit losses to determine effective gross income. Operating expenses like management, taxes, insurance and reserves are then subtracted to get net operating income. This income can be capitalized using market rates or discounted in a cash flow analysis to estimate the property's worth. The document provides an example analysis that values the property at $80,000 using direct capitalization and $103,000 using discounted cash flow.
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590 8
- 1. MBA 590 Real Estate Analysis ! College of Business Alfaisal UNIVERSITY
- 2. Chapter 8 Income Approach
- 3. Estimating Income and Expenses Reconstructing Adding Subtract
- 4. Net Operating Income Income Less: expenses = Net Operating Income (NOI)
- 5. Net Operating Income more details can be complex
- 6. Estimating Income and Expenses usually different than the owner’s statements
- 7. Potential Gross Income If the property was 100% occupied at market rent
- 8. Two loss deductions vacancy loss credit loss
- 9. Vacancy Loss no tenant no Income
- 10. Credit Loss tenant not paying rent
- 11. Effective Gross Income potential gross income less: vacancy loss less: credit loss
- 12. Abbreviations PGI less: CVL EGI
- 13. Gross Income Potential Gross Income (PGI) 10,000 Less: Vacancy Loss 4% 400 Less: Credit Loss 4% 400 8% 800 ! Effective Gross Income (EGI) 9,200
- 14. Operating Expenses reimbursable non-reimbursable
- 15. Operating Expenses management property taxes insurance utilities reserves for replacements maintenance other
- 16. Management Must recognize even if owner operated 4% to 10% of EFI
- 17. Reserves for Replacements Prudent management will build a fund to replace long-lived items
- 18. Differences Owner Reconstructed Management 0 300 Property Taxes 500 500 Insurance 1,000 1,000 Utilities 300 300 Reserves for Replacements 0 500 Maintenance 100 100 Total Operating Expenses 1,900 2,700
- 19. Reconstructed Operating Statement Potential Gross Income 10,000 100% Less: Credit and Vacancy 800 8% Loss Effective Gross Income 9,200 92% Operating Expenses Management 300 3% Property Taxes 500 5% Insurance 1,000 11% Utilities 300 3% Reserves for 500 5% Replacements Maintenance 100 1% Total Operating Expenses 2,700 29% Net Operating Income 6,500 71%
- 20. What is the property worth?
- 21. Two Methods Direct Capitalization Discounted Cash Flow
- 22. Direct Capitalization Convert an annual income into a value with a capitalization rate
- 23. IRV Income = Rate x Value Rate = Income ÷ Value Value = Income ÷ Rate
- 24. Getting Rates Market Built Up
- 26. Rates Sale Price 1,000,000 Net Operating Income 75,000 Multiplier Rate 13.33 Years to Recover Investment Capitalization Rate 7.50% Yield on Investment
- 27. Why are rates different? Risk Factors change in market management liquidity
- 28. Built Up Risk Free Rate US.Treasury Bond 1.5% Management 3.0% Illiquidity 3.0% Volatility 2.0% Capitalization Rate 9.5%
- 29. Net Operating Income 6,500 Rate Value 5% 130,000 6% 108,333 7% 92,857 8% 81,250 9% 72,222 10% 65,000 11% 59,091 12% 54,167 What is the property worth?
- 30. Selecting a rate quality and quantity stabilized volatility judgment
- 31. Sales Comparison calculate rate adjust for differences weigh apply rate
- 32. Rates Sale 1 Sale 2 Sale 3 Sale Price 750,000 5,500,000 287,000 Net Operating Income 60,000 721,000 12,000 Multiplier 12.50 7.63 23.92 Capitalization Rate 8.00% 13.11% 4.18% Comparability Similar Inferior Superior Adjustment 0.00% -5.00% 5.00% Adjusted Rate 8.00% 8.11% 9.18% Average 8.43%
- 33. Weighted Rates Sale 1 Sale 2 Sale 3 Average Adjusted Capitalization Rate 8.00% 8.11% 9.18% 8.43% Weighting 70% 20% 10% 100% Weighted 5.60% 1.62% 0.92% 8.14%
- 34. Indication Net Operating Income 6,500 Capitalization Rate 8.14% Indicated Value 79,853 Rounded To 80,000
- 35. Discounted Cash Flow DCF Present value of all future benefits
- 36. Discounted Cash Flow DCF Return on capital Return of capital
- 37. Discounted Cash Flow DCF 1. Estimate amount of NOI for each period 2. Select a discount rate 3. Calculate PV factor for each period 4. Apply the PV factor to each cash flow 5. Add up the present value of all cash flows
- 38. the present is worth more than the future ! the future is worth less than the present
- 39. time is money ! money is time
- 40. compensated to wait ! patience is rewarded
- 41. time value of money ! money value is relative to time
- 42. Assumptions money value is relative to time
- 43. Assumptions time value of money ! money is worth different based on the time
- 44. Finance Time and Risk how long how much
- 45. Number of periods (1 + rate) (1 + r)N
- 46. Key Formulas r = rate N = number of periods Compounding Future Value or FV multiplying (1+r)N Discounting Present Value or PV dividing 1 (1+r)N
- 47. Tomorrow One Year Ten Years
- 48. Discount the future ! Today is worth more than tomorrow
- 49. Grow in the Future Today One year Ten Years
- 50. Compounding Grow by a percentage each year, not a fixed amount
- 51. Compounding The process of finding the future value of a present sum of money ! multiplying
- 52. Discounting The process of finding the present value of a future sum of money ! dividing
- 53. compounding is the inverse of discounting discounting is the inverse of compounding
- 54. DCF of the NOI Discount Rate 7% 1 2 3 4 5 Total NOI 6,200 6,500 6,800 7,200 7,500 34,200 PV Factor 0.9346 0.8734 0.8163 0.7629 0.7130 0.8147 Present Value 5,794 5,677 5,551 5,493 5,347 27,863
- 55. Reversion return of your capital resale
- 56. Reversion Net Operating Income 7,500 Capitalization Rate 8.14% Indicated Value 92,138 PV Factor 0.8147 Present Value of the 75,064 Reversion
- 57. DCF Face Value Present Value Net Operating Income 34,200 27,863 Reversion 92,138 75,064 Summary 126,338 102,927 Rounded To: 103,000
- 58. Income Approach Direct Capitalization 80,000 Discounted Cash Flow 103,000