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Presentation Transcript

Overview

- Valuation Fundamentals
- Appraisal Process
- Sales Comparison Approach
- Income Approach
- Gross income multiplier (GIM)
- Capitalization rate
- Discounted cash flow

- Highest & Best Use
- Mortgage-Equity Capitalization
- Cost Approach

Valuation Fundamentals

- Market Value
- Most probable price
- Open market and fair sale
- Knowledgeable buyer and seller
- Arms length transaction
- Normal financing

Appraisal Process

- An appraisal is an estimate of value
- It is used as the basis of lending and investing decisions
- Appraisal Process:
- Physical and legal definitions
- Identify property rights to be valued
- Specify the purpose of the appraisal
- Specify the effective date of value estimate
- Gather and analyze market data
- Apply techniques to estimate value

- Three approaches of appraisal
- Sales comparison approach
- Income capitalization approach
- Cost approach

Sales Comparison Approach

- Use data from recently sold “comparables” to derive a “subject” market value
- Adjust comparable sales price for feature differences
- Principles of contribution & substitution
- Lump sum adjustments and square foot adjustments
- Subjective process

Income Approach

- The value of a property is related to its ability to produce cash flows
- Gross income multiplier (GIM)
- Capitalization rate
- Discounted cash flow

Gross Income Multiplier

- Determine comparable property GIM as:
- Apply GIM to the subject property
- If GIM = 6.00x and the subject has gross income = $120,000 then
- Value Estimate = 6.00 x $120,000 = $720,000

Capitalization Rate

- If comparable properties have different operating expenses then instead of GIM, net operating income (NOI) should be used

Capitalization Rate – Continued

- Capitalization Rate Range:
- 0.1320 < R < 0.1377

- The cap rate choice is an educated opinion of the appraiser
- Which property is most similar to the subject?
- If the subject NOI = $58,000, the value estimate could be:
- $58,000 / 0.1320 < V < $58,000 / 0.1377
- $421,205 < V < $439,394

- Care must be taken when determining R

Capitalization Rate – Continued

- Considerations when determining R
- Consider the comparables
- Similarity to subject
- Physical attributes
- Location
- Lease terms
- Operating efficiency

- How is NOI determined?
- Stabilized NOI
- Nonrecurring capital outlays
- Lump sum
- Averaged

- Was NOI skewed by a one-time outlay?

- Similarity to subject

Discounted Present Value

- Compute the present value of future cash flows
- Forecast NOI and holding period
- Select discount rate based on risk and return of comparable investments (r)
- Determine reversion value of property

Discounted Present Value – Reversion Value

- Estimating reversion value
- Not an exact science
- Method 1: Discount remaining cash flows using a terminal cap rate (RT)
- RT = (r – g) constant positive growth (g)
- RT = (r) growth is zero
- RT = (r + g) growth is a decay rate

- Method 2: Estimate RT by adjusting the “going in” cap rate
- RT > going in cap rate
- This is because as properties age their income generation potential diminish

- Method 3: Estimate resale value from expected changes in property value

Discounted Present Value – Example

- A property has a projected year 1 NOI of $200,000. NOI is projected to grow by 4.00% per year for the following 2 years, then by 2.00% per year for the subsequent 2 years at a 1.00% constant rate afterward. Given a required return of 13.00%, what is the value of the property?
- NOI1 = $200,000
- NOI2 = $208,000
- NOI3 = $216,320
- NOI4 = $220,646
- NOI5 = $225,059
- Constant 1.00% growth begins

Discounted Present Value – Example

- Terminal Value = $1,894,250
- Cash flows:
- NOI1 = $200,000
- NOI2 = $208,000
- NOI3 = $216,320
- NOI4 = $220,646
- NOI5 = $225,059 + $1,894,250
- PV @ 13.00% = $1,775,409

Highest & Best Use

- Land value: The residual land value is the difference between total property value driven by rents and cash flows less cost of constructing an improvement on a given site
- Sources of land price volatility
- Speculation
- Changes in valuation of improvements that can be built on the land

- Residual Land Value
- PV – Building Cost = Land Value
- Step 1: Compute the present value of the estimated cash flows for all alternatives
- Step 2: Subtract building cost
- Step 3: Select highest value among the alternatives

Mortgage-Equity Capitalization

- Value = PV of Mortgage Financing + PV of Equity Investment
- Steps:
- Estimate NOI
- Subtract Debt Service from NOI
- Subtract Mortgage Balance from Resale Value
- Discount Cash Flows
- Add Present Value of Cash Flows to Mortgage

Mortgage-Equity Capitalization – Continued

- PV of total cash flow @ 12.00% = $165,566
- Financing is based on debt coverage ratio (DCR) of 1.20 and first year NOI of $50,000.
- Debt service (DS) = $50,000 / 1.20 = $41,667
- Monthly payment = $41,667 / 12 = $3,472
- If the loan rate is 11.00% for 20 year then the loan amount is $336,394
- Property value = $336,394 + $165,566 = $501,960

Valuation Fundamentals

- Reconciliation of Value Estimates
- The sales comparison and income approaches should yield similar value estimates.

- Market Conditions Changes on “Going in” Cap Rates
- Supply & Demand pressures
- Capital market changes
- Capital market & spatial market changes

Cost Approach

- Buyer would not pay more than the value of land plus cost of building the structure
- Estimate the construction cost if new
- Subtract depreciation
- Physical
- Functional
- External

- Add site value

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