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

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$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 buildingsPage 100-101

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 102-103

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

R V

Income

I = Income = Stabilized NOII = 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 105-106

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 = $2,857,142.86• ($200,000 ÷ 7% = $2,857,142.86)

• Owner might expect selling price of $2,857,142.86

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 107-108

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 returnfrom

– Initial investment• Result is a number, not a percentage,

which will be greater than, less than, or equal to zero

Page 108-109

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 (www.ccim.com)• Institute of Real Estate Management

(www.irem.org)

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