Presentation on theme: "Real Property Valuation"— Presentation transcript:
1Real Property Valuation Finance 673Real Property ValuationDepartment of FinanceMays Business SchoolTexas A&M UniversityReplacement Allowance
2Definition Replacement Allowance An allowance that provides for the periodic replacement of building components that wear out more rapidly than the building itself and must be replaced during the building’s economic life (short lived items)One of the three categories of operating expensesFixed expensesVariable expensesReplacement allowanceAlso referred to as replacement reservesIssue – deduct before or after NOI, capitalization of NOI with or without replacement allowance
3Replacement Allowance Items Typical building components requiring replacement allowance:Roof coveringHVAC systemsCarpetingKitchen, bath and laundry equipmentCompressors, elevators and boilersSidewalksDrivewaysParking areasExterior painting
4No Reserve Funding Method Method 1 – Funding No ReservesJudgment based on market evidenceSee if market derived capitalization rates reflect or don’t reflect replacement allowanceRO would be affected, how?Example ANOI $50,000Sales Price $500,000RO %Maintenance Poor ($0/yr.)
5No Reserve Funding Method Example BNOI $47,500Sales price $500,000RO 9.5%Maintenance GoodConclusion: Increase of 50 basis points (adjustment) to RO for poor maintenance
6Percentage of NOI Method Method 2 – Funding based on percentage of NOISimplestBut weakestAs NOI increases, reserves increase similarlyWhat is relationship?
7Straight Line Method Method 3 – Straight line method Usually based on per square foot, per unitGood if properly developedSimpleStraight line amortization of replacement costExample:Replacement cost = $100,000 (short lived item)10 year useful life100,000 square foot buildingTotal allowance = $100,000 ÷ 10 = $10,000 per yearPer unit = $10,000 ÷ 100,000 square feet = $ psf
8Sinking Fund Factor Method Method 4 – Sinking Fund Method1. Sinking Fund Factor (SFF) calculation:Reinvestment rate of 4.5%PV = 0FV = 1i = 4.5n = 10Solve for pmt. =
9Sinking Fund Factor Method 2. Estimate replacement allowanceSFF =Allowance = SFF x replacement cost= x $100,000= $8,137.903. Compare to straight line:$8, v. $10,000.00Why are they different?Under what circumstances would they be the same?
10Sinking Fund with Inflation Assumptions:Current replacement cost of $100,000, increasing at 2.0% per year, compounded annuallyUseful life of 10 years (short lived item – useful life less than the useful life of the main structure)Reinvestment (sinking fund) rate of 4.5%
11Sinking Fund with Inflation Solution:Calculate future replacement costPV = -$100,000i = 2.0%n = 10calculate FV = $121,899.442. Calculate replacement allowanceSFF =Allowance = SFF x cost= x $121,899.44= $9,920.05