Income Approach-Appraisal Theory

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Income Approach-Appraisal Theory

• Anticipation- Market value accounts for the
  present worth of future benefits or detriments
  associated with the ownership of property.
• Time Value of Money- An amount of money, expected
  to be receivable in the future is always worth
  less than an equal amount actually in hand at
  present.

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Income CapitalizationPrinciple

• Income capitalization is a process of converting
  income into value
• The price a buyer should be willing to pay for a
  property would be to the present worth of
  these benefits
• In the income approach the appraiser discounts
  such anticipated future income to its present
  worth

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3 Essential Variablesin theCapitalization
Process

• Income- A projection of future gross
  income,effective gross income,net income, before
  recapture and taxes.
• Discount Rate-The present worth of future
  benefits.
• Capitalization Methods- An income stream
  converted into a value.( I.e. Dividing a single
  years NOI by an appropriate capitalization rate)

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Income-Types of Rent

• Market Rent-The rent the property is capable of
  producing
• Contract Rent-The actual rent paid
• Excess rent
• Percentage rent

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CAMCommon Area Maintenance Income- income
collected from tenants for the operation and
maintenance of common areas
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Vacancy and Collection Loss
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Miscellaneous IncomeCovers all income generated
by the operation of the real property that is not
derived from the rental of space

• Parking fees
• Vending machines

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Effective Gross Income

• Gross income(potential gross income,includes CAM
  income)
• ltVacancy and collection loss gt
• Miscellaneous income
• Effective gross income

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Allowable Operating Expenses

• Management
• Insurance
• Utilities
• Maintenance and repairs
• Legal and accounting fees
• Employees wages and benefits
• Yard care
• Misc. expenses(advertising, etc)

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Replacement and Reserves

• Short-lived items which are expected to have a
  remaining economic life less than the remaining
  life of the property. Some examples are carpets,
  drapes, central air/heat units, appliances, water
  heaters. This is calculated by dividing the RR
  cost/number of years of total life.

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Income Approach Using directCapitalization

• Potential gross income-from the property includes
  the annual income from all sources
• Effective gross income-estimated by subtracting
  anticipated vacancy collection losses from
  potential gross income
• Net Operating Income-calculated by deducting
  normal annual operating and other expenses from
  the effective gross income

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Capitalization Rate and Risk

• Several generalizations can be made about the
  relationship between the cap rate and the risk of
  an investment
• High risk High Cap rate
• Low risk Low Cap rate

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Basic Capitalization Formulas__I___ R V

• I Represents Income to be capitalized
• R Represents rate, may be called investment rate
  or capitalization rate
• V Represents market value

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Rate of Return

• Discount rate-The return an investor anticipates
  on his investment
• Recapture rate-The rate at which an investment is
  returned to the investor. To develop a recapture
  rate divide 1 by the number of economic years
  left in the building. 1/40 2.5 (straight line
  method)

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Rate of Return-Part B

• Effective tax rate example- Level of
  Assessment(LOA) multiply by the Millage rate
  .85x.02.017
• Loaded overall rate - Includes the effective tax
  rate.
• There is a danger in becoming totally engrossed
  in the mechanics and mathematics of
  capitalization. Sound appraisal judgement must be
  used and all appropriate supply and demand
  factors must be considered with the application
  of the capitalization procedure.

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Income CapitalizationApproachReview

• Research market rents
• Estimate potential gross income
• Allowance for vacancy and collection
• Calculate operating expense including reserve and
  replacement
• Estimate net income
• Calculate capitalization rate

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Gross Income Multipliers

• Gross income multipliers are used to compare the
  income producing characteristics of properties in
  the sales comparison approach.
• The properties analyzed must be comparable to the
  subject property and to one another in terms of
  location, physical, and investment
  characteristics.
• A gross income multiplier applies to rental
  income only.

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Gross Income Multipliers -B

• The appraiser must use similar income data to
  derive the multiplier for each transaction
• The timing of income also must be comparable
• Potential gross income multiplier Sale
  price/Potential gross income