VALUATION BY INCOME CAPITALIZATION

1. VALUATION BY INCOME CAPITALIZATION LEARNING OBJECTIVES • Explain the difference between appraisal and investment analysis. • Estimate the NOI in a reconstructed operating statement. • Identify the two main components of capitalization rates.

2. VALUATION BY INCOME CAPITALIZATION LEARNING OBJECTIVES • Calculate overall capitalization rates by the general formula, market extraction, and mortgage-equity analysis • Estimate a property’s market value by direct capitalization, using an overall rate. • Estimate the market value of a leased fee estate, using DCF analysis.

3. VALUATION MODELS IN THE INCOME APPROACH • Discounted Cash Flow Analysis • value estimated as: the present value of the expected cash flows • Investment value uses the expected cash flows and discount rate of a particular investor. • Market value uses the expected cash flows and discount rate of the typical market participant. • Direct Capitalization • value estimated as: V = NOI / R

4. DCF: Expected Cash Flows (NOIs) from Operations

5. DCF: Expected Net Proceeds from Sale

6. Present Value of Expected Cash Flows (before debt)

7. DCF using Expected Before-Tax Cash Flows • Assume the following loan terms available to a particular investor: • loan-to-value ratio = 80%, • thus, loan amount = $944,000 x 0.80 = $755,200 • interest rate is 9.5%, amortized over 30 years, paid monthly • thus, annual debt service = $6,350 x 12 = $76,202 • Assume the return required of the investor is 18 percent

8. DCF: Expected BTCFs from Operations

9. DCF: Expected BTER from Sale

10. Present Value of Expected Cash Flows (BTCFs)

11. DIRECT CAPITALIZATION • The Income Capitalization Equation is: V = I / R, where V = value, I = income, and R = capitalization rate. • Often used to estimate R, when V and I are known. R = I / V

12. The Reconstructed Operating Statement • Potential Gross Income • Vacancy and Collection Losses • Expenses • fixed • variable • reserves and other nonrecurring expenses • expense exclusions • Net Operating Income

13. The Reconstructed Operating Statement

14. Direct Capitalization Estimate • The Income Capitalization Equation is: V = I / R, where V = value, I = income, and R = capitalization rate. • Assume capitalization rate is estimated to be 9.2% • Indicated value using the direct income capitalization approach: V = $ 86,600 / .092 = $ 934,783 rounded to $ 934,800

15. Capitalization Rates and Yield Rates • The overall capitalization rate can be explained as: RO = yO - g, where RO = the overall capitalization rate yO = the discount rate (or yield rate), and g = the expected annual compounded rate of growth.

16. Capitalization Rates

17. Direct Market Extraction of RO

18. Simple Mortgage-Equity Analysis RO = [mRm + (1-m)Re], where RO = the overall capitalization rate, m = loan-to-loan ratio, Rm = mortgage capitalization rate, and Re = equity capitalization rate.

19. Mortgage-Equity Analysis Example