Chapter 1 the nature of real estate and real estate markets
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- Reconstructed Operating Statement
Estimating vacancy and collection losses at 5 percent of potential gross income, reconstruct the operating statement to obtain an estimate of NOI. Remember, there may be items in the owner’s statement that should not be included in the reconstructed operating statement. Using the NOI and a Ro of 11.0 percent, calculate the property’s indicated market value. Round your answer to the nearest $500. Solution:
Note: Mortgage payments and depreciation are not included in the calculation of the property’s NOI. The indicated value of the property is $362,727 ($39,900 / 0.11), which rounds to $363,000.
Comparable 1: Sale price $500,000; NOI $55,000 Comparable 2: Sale price $420,000; NOI $50,400 Comparable 3: Sale price $475,000; NOI $53,400 Comparable 4: Sale price $600,000; NOI $69,000
Comparable 2: 0.120 Comparable 3: 0.112 Comparable 4: 0.115 Simple Ave. 0.114
a. If you expect that NOI will remain constant at $100,000 over the next 50 years and that the office building will have no value at the end of 50 years, what is the present value of the building assuming a 12.2% discount rate? If you pay this amount, what is the indicated initial cap rate? Solution: The present value, using a financial calculator, is $817,078.
The initial (going-in) cap rate is $100,000/$817,078 = 12.24% b. If you expect that NOI will remain constant at $100,000 forever, what is the value of the building assuming a 12.2% discount rate? If you pay this amount, what is the indicated initial cap rate? Solution: The value of the building with NOI remaining constant at $100,000 is calculated using the formula for a perpetuity, which is $100,000/0.122, or $819,672. If you pay $819,672 for the property, the initial (going-in) cap rate is 12.2% ($100,000 / $819,672). c. If you expect the initial $100,000 NOI will grow forever at a 3% annual rate, what is the value of the building assuming a 12.2% discount rate? If you pay this amount, what is the indicated initial cap rate? Solution: The capitalization rate consists of a required IRR on equity and a growth rate. Applying the general constant-growth formula and assuming that the growth rate is 3%, the indicated capitalization rate is equal to 9.2% (12.2% - 3.0%.). Therefore, using a cap rate of 9.2%, the indicated value of the building is $100,000/0.092, or $1,086,957.
Solution: The use of gross income multipliers is predicated on two primary assumptions. First, it is assumed that the operating expense percentage of the subject property and the comparable properties are equal. Second, this approach assumes that the subject property and comparable properties are collecting market rents. In practice, gross income multipliers are most appropriate for valuing apartment buildings.
Solution: Direct capitalization is dependent on information obtained from sales of properties that are deemed to be comparable to the subject property. Identifying comparable properties is particularly difficult with commercial real estate investments. Discounted cash flow analysis is useful for valuing income-producing properties because the unique expected cash flows for a particular property are evaluated using the appropriate required internal rate of return. DCF is especially useful when valuing multi-tenant office buildings and shopping centers were lease terms can vary widely across even otherwise similar properties.
Solution: The use of mortgage debt to finance the acquisition of a real estate investment property is referred to as leverage. Levered cash flows measure a property’s income stream after deducting debt service payments. The amount of cash flow available for distribution to an equity investor is reduced by the amount paid to the lender. Therefore, the equity investor has a residual claim, known as the before-tax cash flow, which is simply NOI less debt service.
Solution: A fee simple estate is the highest form of property ownership. It is complete ownership of a property without regard to leases. A leased fee estate is ownership of a property subject to leases on the property. When acquiring existing commercial real estate, investors are most often acquiring a leased fee estate because they are acquiring the property subject to the existing leases.
Solution: Contract rent refers to the actual rent paid under existing lease contracts executed between owners and tenants. Market rent refers to the potential rental income a property could receive on the open market as of the effective date of an appraisal. The distinction is particularly important for investors in office buildings because commercial leases tend to be for multiple years, unlike apartment leases. Existing leases at below market rates will be included in the calculation of potential gross income, which will depress the appraised value of the property relative to the appraised value assuming market rental rates.
During the remaining term of the lease, there will be no vacancy and collection losses; however, upon termination of the lease it is expected that the property will be vacant for three months. When the property is released under short-term leases, with tenants paying all operating expenses, a vacancy and collection loss allowance of 8 percent per year is anticipated. The current market rental for properties of this type under triple net leases is $11 per square foot, and this rate has been increasing at a rate of 3 percent per year. The market discount rate for similar properties is about 11 percent, the "going-in" cap rate is about 9 percent, and terminal cap rates are typically 1 percentage point above going-in cap rates. Prepare a spreadsheet showing the rental income, expense reimbursements, NOIs, and the net proceeds from the sale of the property at the end of an 8-year holding period. Then use the information provided to estimate the market value of the property. Solution: The fifth year of the 10-year lease is the first year of analysis. The problem calls for an 8-year analysis--one for the last year of the 1st 5-year period, five for the second 5-year period, one to allow the vacancy and collection loss to achieve a normal level, and one at the normal level for calculating the property's value (sale price) at that time. Assume vacancy and collections losses in year 7 are 25 percent, which reflects 100 percent vacancy for three months and no vacancy for 9 months. Assume the “normal” vacancy rate of 8 percent will apply in year 8 of the analysis and beyond.
Sale price at the end of Yr. 8: = [NOI (yr9) / Terminal cap rate] = $134,606 / 0.10 = $1,346,060 Cash Flows: CF1 = 114,300 CF2 = 135,900 CF3 = 135,900 CF4 = 135,900 CF5 = 135,900 CF6 = 135,900 CF7 = 103,435 CF8 = 1,476,746 (130,686+1,346,060) PV of Cash Flows @ 11 percent = $1,246,090 Directory: ~kcchiang ~kcchiang -> Chapter 1 globalization and the multinational firm answers & solutions to end-of-chapter questions and problems Download 206.78 Kb. Share with your friends:
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