2CHAPTER TERMS AND CONCEPTS Amenities Capital recovery Capitalization Capitalization rate Contract rent CPI lease Direct capitalization Effective gross income Excess rent Fixed expenses Gross income Gross income multiplier (GIM)Income propertyIntangible benefitLease termMarket rentMinimum or base rentNet income ratioNet operating incomeOperating expense ratioOperating expensesOperating statementOverage rentPercentage lease
3CHAPTER TERMS AND CONCEPTS Potential gross income Present worth of future benefits Recapture Rent roll Reserves for replacements Return of investment Return on investment Step-up (or “graduated”) lease Straight (or “flat”) lease Tangible benefit Variable expenses
4LEARNING OUTCOMESDistinguish between the tangible and intangible benefits of property ownership.Name the six steps in the income approach to value.Explain the use of gross income multipliers in the income approach.Define the terms contract rent and market rent as used in appraisals.Name the three main categories of expenses and give examples of items in each.Outline the procedure used for reconstructing the owner’s operating statement.
5Types of Income Property 1. Multiple-family residential, including large and small apartment buildings. 2. Commercial buildings, including stores, offices, medical offices, convalescent hospitals, hotel and motel properties, and shopping centers. 3. Industrial properties, such as warehouses and factories.
6MOTIVES AND BENEFITS OF PROPERTY OWNERSHIP Intangible BenefitsPride of ownershipSense of securityPersonal opportunityTangible BenefitsReturn on investmentReturn of investment
7CHARLEY’S SAVING ACCOUNT How Much is in Charley’s Savings Account?Amount on Deposit?$216$600$360$6,000Hi Charley! Here’s your $36 annual check!We give 6%
8Capitalizationthe process of converting an income estimate into a value estimate.
9IRV FOR VALUE The Value Formula Key Formulas Horizontal line indicates divisionVertical line indicates multiplicationFormulasValue = I/RRate = I/VIncome = R X V
10BASIC STEPS: INCOME APPROACH Estimate the Annual Gross IncomeEstimate Vacancy and Other LossesSubtract to Get Effective Gross IncomeSubtract Operating Expenses to Get Net Operating IncomeArrive at a “Cap” Rate and MethodDivide Net Operating Income by Capitalization Rate
11Analysis of GIM Gross Income Multipliers GIM = Price ÷ Gross Income Price Gross Income GIM$300, $30,$250, $30,$200, $30,Effect of Expense RatiosGross%NetCapIncomeExpensesRatePriceGIM$30,00040.00%$18,0006%$300,0001050.00%$15,000$250,0008.360.00%$12,000$200,0006.7
12Analysis of GIM GIM Varies with: Location Intangible Amenities Number of UnitsExpense RatioSize of UnitsServices Included
13MARKET RENT Market Rent Defined Potential gross rent Assumes no encumbrancesAssumes efficient managementMeasures all the property rightsOverage RentExcess RentResponsibility for ExpensesLandlordTenantShared
14Contract Rentrent being paid under some form of contract that is binding on both owners and tenants. Such rental agreements range from simple oral contracts to complex leases that are beyond the scope of this book.
15CONTRACT VS. MARKET RENT Types of tenanciesMonth to MonthShort-term LeaseLong-term LeaseCommon Lease TypesStraightStep UpPercentageCombinations
16Include Property-Related Expenses OPERATING EXPENSESWhat to Include:Include Property-Related ExpensesCurrent Operating ExpensesProjected ExpendituresThe Value of Owners EffortsExclude Owner-Related Expenses, such as:Loan and Interest PaymentsIncome TaxesDepreciation
17OPERATING EXPENSES CATEGORIES Operating Expense CategoriesVariable ExpensesFixed ExpensesReserves for Replacement
18INCOME AND EXPENSE RATIOS The Net Income Ratio = NOI ÷ EGIThe Operating Expense Ratio = Operating Expenses ÷ EGINOI = Net Operating IncomeEGI = Effective Gross Income
21SUMMARYAn overview of the income approach as it applies to various types of residential income, commercial, and industrial properties was also included. The income approach can either analyze the income year-by-year, or by emphasizing one year. Income property appraisals require an estimate of income and expenses for the property. A knowledge of typical expense ratios assists in the reconstruction of operating expense statements.