Global Real Estate: Transaction Tools Chapter 6: Value Concepts

In This Chapter Comparing values Sales, cost, and income approaches Helping buyers make informed decisions Page 92

Investment Analysis Commercial investors expect detailed and thorough analysis Even vacation-home buyers often view purchase as investment Resource: Realtors Property Resource® (RPR) Page 93

Investment Elements Yield Safety Leverage Control Page 95-97

Time/Value of Money Present value of money is more than future value Would you prefer $1,000 today or $1,000 in the future? Why isn’t the sum the same? Page 97

Example: Time/Value of Money Page Present value of $1000 in 3 years with 2% inflation – Discounted Future Value of $1000 in 3 years growing at 3.5% – Compounded $1000 $941 $1108 $1000

The 7/10 Rule How long does it take for an investment to double in value? 7 years at 10% - OR - 10 years at 7% Page 99

The #1 Question What is the value of the property? Page 100

Sales Approach Compare actual current market values of similar properties CMA Single-family homes and small properties Page 100

Cost Approaches Reproduction: duplication Replacement: reconstruction using current materials and methods – Comparison cost per square foot – Segregated costs – Quantity survey – Index New, one-of-a-kind, historic buildings Page

Income Approaches Gross rent multiplier Net operating income (NOI) and cash flow Income capitalization Cash on cash (ConC) Net present value Internal rate of return (IRR) Page 101

Gross Rent Multiplier (GRM) Sales price ÷ PRI = GRM – PRI is one year Expressed as a number Compare small income and similar properties Page 102

Example: GRM Property priced at $450,000 has a monthly PRI of $1,500 from each of 4 apartments GRM = Sales Price ÷ one-year PRI GRM = $450,000 ÷ ($1,500 x 4 apartments x 12 months) GRM = $450,000 ÷ $72,000 GRM = 6.25 Page 102

Net Operating Income (NOI) Gross Potential Rental Income (PRI) - Vacancy and Credit Losses + Other Income = Gross Operating Income - Expenses = Net Operating Income (NOI) Page

Example: NOI Gross Potential Rental Income (PRI) $115,000 -Vacancy and Credit Losses 9,900 + Other Income 700 = Gross Operating Income 105,800 -Expenses 22,300 = Net Operating Income (NOI) 83,000 Page 103

Cash Flow Cash Flow Before Taxes (CFBT) is figured by subtracting the amount of annual debt service from NOI Cash Flow After Taxes (CFAT) is figured by subtracting income tax owed from cash flow before taxes Page 103

Income Capitalization (Income, Rate, and Value) Market valuation of a property based upon a one-year projection of income – Relies on a single year’s stabilized NOI to estimate the value Net Operating Income (I) ÷ Capitalization Rate (R) = Value (V) Page 104

IRV Formula Page 104 I RV

Income I = Income = Stabilized NOI Page 105

Rate R = Capitalization Rate (cap rate) Single rate that converts a single year’s income into value Sources of cap rates Page

Example: Finding the Cap Rate Retail building bought for $3.25 million with NOI of $295,000 Calculate the cap rate (R) NOI (I) ÷ Value (V) = Cap Rate (R) 295,000 ÷ 3,250,000 = 9.08% Cap rate is 9.08% Page 107

Example: Finding Income Initial value of townhouse in first year of investment at $200,000 with a cap rate of 7% Calculate the NOI (I) Value (V) × Cap Rate (R) = NOI (I) $200,000 (V) × 0.07 (R) = $14,000 (I) ($200,000 × 7% = $14,000) First-year NOI is $14,000 Page 107

Example: Finding Value Suburban office building has NOI of $200,000 and cap rate of 7% Calculate the market value NOI (I) ÷ Cap Rate (R) = Value (V) $200,000 ÷ 0.07 = $2,857, ($200,000 ÷ 7% = $2,857,142.86) Owner might expect selling price of $2,857, Page 107

Cash on Cash (ConC) Measures investor’s desired rate of return on initial investment Compares equity invested in property with cash flow, before or after taxes, from one year Cash Flow ÷ Initial Equity = Cash on Cash Page

Example: Cash on Cash Warehouse will cost a total of $1,000,000 Annual NOI of $95,000 Client can get loan for $800,000 with annual debt service payments of $77,000. The client will put down $200,000. Cash Flow ÷ Initial Equity = Cash on Cash Before Tax Cash Flow = $95,000 NOI – $77,000 Annual Debt Service = $18,000 $18,000 ÷ $200,000 (down payment) = 9.0% Cash on Cash is 9.0% Page 108

Net Present Value (NPV) Calculated by subtracting: – Present value of future cash flows and – Sales price discounted by the investor’s desired rate of return from – Initial investment Result is a number, not a percentage, which will be greater than, less than, or equal to zero Page

Internal Rate of Return (IRR) Discounts the net present value of all cash flows to zero in order to find the actual rate of return In other words, discount rate at which the present value of an investment is equal to the present value of the cash flow of the investment Page 109

Downloadable Forms NPV and IRR are complex calculations Financial calculator or pre-programmed spreadsheet – CCIM Institute Page 110

For Further Study CCIM Institute ( Institute of Real Estate Management ( Page 110

Key Point Review