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Chapter 15 Valuation Analysis: Income Discounting and Cap Rates

Chapter 15 Valuation Analysis: Income Discounting and Cap Rates. Major Topics. Simple multiplier models of value The income approach to value The derivation of a capitalization rate Overall market rate capitalization. Value. Value of any asset = PV of expected future CF’s

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Chapter 15 Valuation Analysis: Income Discounting and Cap Rates

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  1. Chapter 15Valuation Analysis: Income Discounting and Cap Rates

  2. Major Topics • Simple multiplier models of value • The income approach to value • The derivation of a capitalization rate • Overall market rate capitalization

  3. Value • Value of any asset = PV of expected future CF’s • Estimating expected future CF’s? • Holding period? • Financing terms? • Simplifications • Capitalize: to convert future income into a present value • Gross Rent Multiplier • Capitalization Rate

  4. Reconstructed Operating Statement PGI Potential Gross Income • Vac Vacancy Allowance + MI Miscellaneous Income = EGI Effective Gross Income • OE Operating Expenses • NOI Net Operating Income • NOI ≈ EBITDA

  5. Gross Rent (PGI) Multiplier • GRM (Gross Rent Multiplier) • = Price / Gross Rent (PGI) • Quick indicator of value for smaller rental properties • Presumption: “Whatever investors are willing to pay for similar property per dollar of gross rent they should be willing to pay for a subject property” • GRM should be found from comps with: • Similar ages, turnover, growth projections

  6. Comparable A B C Recent sale price $876 ,400 $986,900 $776,300 Potential gross income $158,200 $175,300 $143,500 GRM (sale price / PGI) 5.54 5.63 5.41 Average GRM = 5.53 = GRM Example  PGI = $162K Value of subject = 5.53 x PGI = 5.53 x $162,000 = $895,860

  7. Capitalization Rate • Cap Rate = NOI1 P0 • Similar to reciprocal of PE Ratio (P0 EPS1), except pre-tax • Why do PE ratios differ across stocks? • Cap Rates should be similar for similar properties

  8. Cap Rates and Required Return • P0 = D1÷ (r – g) • Flip and solve for r: • r = D1/ P0 + g • g = expected growth; expected cap gain yield • D1/ P0 = Dividend yield • Flip again: • D1/ P0 = r – g • Cap rate ≈ D1/ P0 = r – g • What influences cap rates?

  9. What influences cap rates? • Economic conditions • Market conditions  S & D of/for similar properties • Type of property • Age of property

  10. “Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner

  11. Sources of Cap Rates • RealtyRates.com: www.realtyrates.com • Other appraisers and market participants

  12. Capitalization Rate • If we know market Cap Rate, and we estimate NOI1, we have an estimate of market value of property. • Buying apartment complex: • Cap Rate on San Marcos apartments = 8% • Expect NOI1 to be $85,000. • How much to bid?

  13. Capitalization Rate • Cap Rate = NOI1 V0 • V0 = NOI1 Cap Rate • V0 = $85,000  0.08 • V0 = $1,062,500 • Austin market: rents increase faster  what should change? • Lower expected inflation  what should change?

  14. END

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