402-PT – Revision 2 – 01.10..07.INT

1

Welcome to the International Right of Way

Association’s

Course 402Introduction to the Income

Capitalization Approach

402PPT.R3.2014.01.21.0.0

2

Introductions

Who we are…What we do…

Where we do it…

How long we’ve been doing it…

Our goals for the day...

3

Objectives (1)

At the conclusion of the day,you will be able to...

• Express an understanding of the valuation process and the income capitalization approach

• Appreciate the differences between direct and yield capitalization

4

Objectives (2)

At the conclusion of the day,you will be able to...

• Apply the income capitalization approach (direct capitalization)to specific valuation situations

5

Housekeeping

6

Schedule

8:00 - 8:30 Introductions, Etc.

8:30 - 9:00 Valuation Process

9:00 - 9:30 Income Capitalization Approach

9:30 - 10:00 Direct and Yield Capitalization

10:15 - 3:00 Components of Direct Capitalization

3:00 - 3:45 “After Value” and Compensation

3:45 - 4:00 Summary and Review

4:00 - 5:00 Exam

7

Valuation Process

Appraisal Problem Definition

Scope of Work

Data Collection/Selection/Analysis

Land Value Opinion

Three Approaches to Value

Reconciliation and Final Value Opinion

Defined Value Opinion Report

8

Highest and Best Use

The reasonably probable and legal use that is physically possible, appropriately supported,

and financially feasible, and that results in the highest value.

• Physically possible?

• Legally permissible?

• Financially feasible?

• Maximally productive?

9

Three Approaches to Value

Cost Approach

Sales Comparison

Income Capitalization Approach

10

Cost Approach

• Develop a value opinion for the land

• Estimate the cost new of the improvement

• Deduct depreciation

• Add land value opinion to the depreciated improvement value

11

Sales Comparison Approach

• Research the market for comparable data

• Develop relevant units of comparison

• Compare the sales to the subject and adjust for dissimilarities

• Reconcile the value indications intoa final value opinion

12

Income Capitalization Approach

In developing a property value opinion by the income capitalization approach, the appraiser converts income into value through the application of a rate or a ratio.

13

Valuation Process

Appraisal Problem Definition

Scope of Work

Data Collection/Selection/Analysis

Land Value Opinion

Three Approaches to Value

Reconciliation and Final Value Opinion

Defined Value Opinion Report

14

Income Capitalization Approach

In developing a property (market) value opinion by the income capitalization approach, the appraiser converts (net operating) income into (market) value through the application of a (overall capitalization or yield) rate or ratio (multiplier).

15

Formulas

Value = Net operating income Capitalization rate

V = I R

Net operating income = Capitalization rate x Value

I = R x V

Capitalization rate = Net operating income Value

R = I V

16

Example

Value = Net operating income Capitalization rate

V = I R

V = $75,000 .105

V = $714,286

17

Exercise No. 1Value = Net operating income Capitalization rate

V = I R

V = $48,000 .12

V = $400,000

Capitalization rate = Net operating income Value

R = I V

R = $33,000 $300,000

R = .11

18

Direct/Yield (1)

19

20

21

22

Income Capitalization Approach

• Estimate the subject’s potential gross income

• Determine a vacancy and collection loss

• Subtract the vacancy and collection loss from the potential gross income

• Estimate annual operating expenses and subtract the expenses from the effective gross income to arriveat the net operating income

• Develop a capitalization rate

• Convert the net operating income into value

23

Case Study(1)

PGI = $43,375

24

Case Study(2)

PGI = $43,375

V&C = - 4,338

EGI = $39,037

25

Expenses

Fixed

Variable

Replacement allowances

26

Case Study(3)

PGI = $43,375

V&C = - 4,338EGI = $39,037 Expenses = -

16,025NOI = $

23,012

27

Band of Investment

Ro = (M x RM) + (E x RE)

28

Market

Ro = I V

29

Case Study(4)

Ro = (M x RM) + (M x RM) + (E x RE)

Ro = (.70 x .1096) + (.15 x .1699) + (.15 x .16)

Ro = .1262 or 12.62%

30

Case Study(5)

Sale No. 1: Ro = I V or Ro = $25,870 $205,000 or 12.62%

Sale No. 2: Ro = I V or Ro = $22,085 $175,000 or 12.62%

Sale No. 3: Ro = I V or Ro = $22,527 $178,500 or 12.62%

31

Case Study(6)

PGI = $43,375V&C = - 4,338EGI = $39,037 Expenses = -

16,025NOI = $

23,012

$ 23,012 .1262 = $182,345

32

Case Study(7)

PGI = $41,875V&C = - 6,281EGI = $35,594 Expenses = - 15,540NOI = $

20,054

$ 20,054 .1262 = $158,906

33

Case Study(8)

Before value = $182,345

After value = $158,906

Compensation = $ 23,439

34

Objectives (1)

Now, you are able to...

• Express an understanding of the valuation process and the income capitalization approach

• Appreciate the differences between direct and yield capitalization

35

Objectives (2)

Now, you are able to...

• Apply the income capitalization approach (direct capitalization) to specific valuation situations

36

Thank you!

402PPT.R3.2014.01.21.0.0