# Chapter 13 THE INCOME APPROACH.

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Chapter 13 THE INCOME APPROACH

CHAPTER 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 property Intangible benefit Lease term Market rent Minimum or base rent Net income ratio Net operating income Operating expense ratio Operating expenses Operating statement Overage rent Percentage lease

CHAPTER 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

LEARNING OUTCOMES Distinguish 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.

Types 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.

MOTIVES AND BENEFITS OF PROPERTY OWNERSHIP
Intangible Benefits Pride of ownership Sense of security Personal opportunity Tangible Benefits Return on investment Return of investment

CHARLEY’S SAVING ACCOUNT
How Much is in Charley’s Savings Account? Amount on Deposit? \$216 \$600 \$360 \$6,000 Hi Charley! Here’s your \$36 annual check! We give 6%

Capitalization the process of converting an income estimate into a value estimate.

IRV FOR VALUE The Value Formula Key Formulas
Horizontal line indicates division Vertical line indicates multiplication Formulas Value = I/R Rate = I/V Income = R X V

BASIC STEPS: INCOME APPROACH
Estimate the Annual Gross Income Estimate Vacancy and Other Losses Subtract to Get Effective Gross Income Subtract Operating Expenses to Get Net Operating Income Arrive at a “Cap” Rate and Method Divide Net Operating Income by Capitalization Rate

Analysis of GIM Gross Income Multipliers GIM = Price ÷ Gross Income
Price Gross Income GIM \$300, \$30, \$250, \$30, \$200, \$30, Effect of Expense Ratios Gross % Net Cap Income Expenses Rate Price GIM \$30,000 40.00% \$18,000 6% \$300,000 10 50.00% \$15,000 \$250,000 8.3 60.00% \$12,000 \$200,000 6.7

Analysis of GIM GIM Varies with: Location Intangible Amenities
Number of Units Expense Ratio Size of Units Services Included

MARKET RENT Market Rent Defined Potential gross rent
Assumes no encumbrances Assumes efficient management Measures all the property rights Overage Rent Excess Rent Responsibility for Expenses Landlord Tenant Shared

Contract Rent rent 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.

CONTRACT VS. MARKET RENT
Types of tenancies Month to Month Short-term Lease Long-term Lease Common Lease Types Straight Step Up Percentage Combinations

Include Property-Related Expenses
OPERATING EXPENSES What to Include: Include Property-Related Expenses Current Operating Expenses Projected Expenditures The Value of Owners Efforts Exclude Owner-Related Expenses, such as: Loan and Interest Payments Income Taxes Depreciation

OPERATING EXPENSES CATEGORIES
Operating Expense Categories Variable Expenses Fixed Expenses Reserves for Replacement

INCOME AND EXPENSE RATIOS
The Net Income Ratio = NOI ÷ EGI The Operating Expense Ratio = Operating Expenses ÷ EGI NOI = Net Operating Income EGI = Effective Gross Income

An Owner’s Operating Statement

A Reconstructed Operating Statement

SUMMARY An 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.

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