Income Approach (Part 1)...
Return On (Definition)
"Return on" is interest and "return of" is principal
What rates are used in the sinking fund premise for calculating replacement allowances?
Property yield rate or safe rate, depending on the item
What does (1-M) represent in the formula relating Ro and the components Rm and Re?
Proportion of value attributable to equity
With band of investment problems, we know that there is ____ between the components; neither component's value is given.
Proportional distribution
The two primary adjustment techniques used to estimate market rents are...
Quantitative and Qualitative
Net Lease
The tenant pays a stated rent every month, plus all operating expenses, possibly with the exception of structural repairs.
Modified Gross Lease
The tenant pays a stated rent every month, plus some expenses such as utilities and landscape/parking lot maintenance.
In mortgage-equity residual technique, what do the non-subscripted symbols M, E (or 1-M), and V stand for?
Mortgage ratio, equity ratio, and value amount
When reimbursements are above a base year, What does the tenant do for expenses that exceed the level of the base year?
Reimburses the landlord for the expenses
Published national surveys (Office Buildings):
- Building Owners and Managers Association (BOMA) - Institute of Real Estate Management (IREM)
Published national surveys (Apartments):
- IREM - ULI
Published national surveys (Shopping Centers):
- International Council of Shopping Centers (ICSC) - IREM - Urban Land Institute (ULI)
Published national surveys (Hotel Properties):
- STR Global - PKF Hospitality Research
Technique for Loading Cap Rates in Assessment Appeals (6 Steps):
1) Calculate the effective tax rate 2) Calculate the property's net operating income without deducting property taxes as an expense 3) Add the reconciled overall cap rate (Ro) to the effective tax rate 4) Apply this loaded rate to the NOI that excludes a deduction for property taxes (this gives the property's market value (Vo). 5) Multiply the tax rate by the property's market value to get the estimate of property taxes 6) Calculate the net operating income including taxes to complete the operating statement
What are 3 synonyms for the equity capitalization rate?
1) Cash-on-Cash Rate 2) Cash Throw-Off Rate 3) Equity Dividend Rate
Disadvantages of Direct Capitalization:
1) Difficult to use with special rent patterns 2) Difficult to use with multi-tenant properties where leases are at different levels 3) Difficult to find capitalization rates for partial interests
What are the two methods of income capitalization?
1) Direct Capitalization 2) Yield Capitalization
Advantages of Direct Capitalization
1) Easy to estimate first year income 2) Easy to support 3) Easy to explain
Collection Losses (Examples of Considerations & Concerns)
1) Existing tenants may not pay all the rent owed 2) Collection loss should reflect prudent management (no better and no worse) 3) Collection loss is typically applied to potential gross income and considered a separate category from vacancy, but it is often presumed to be in the vacancy rate.
Name the 6 "Factors of One":
1) Future Value of One 2) Future Value of One per Period 3) Sinking Fund Factor 4) Present Value of One 5) Present Value of One per Period 6) Installment to Amortize One
The 3 types of leases....
1) Gross 2) Modified Gross 3) Net
What are the three primary algebraic formulas used in residual analysis?
1) IRV 2) Sum of the income components 3) Sum of the value components
Examples of Other Income:
1) Laundry room income from an apartment building 2) Parking income from office, apartments, and retail buildings 3) Outdoor advertising sign leases (billboards) and antenna income from any property type 4) Vending machines 5) Telephones (hotels or motels)
The income stream and value associated with a property can be divided in four ways....
1) Legally 2) Physically 3) Financially 4) Economically
Examples of Variable Expenses:
1) Management Expenses 2) Utilities 3) Heating Ventilation & Air Conditioning (HVAC) 4) Personnel 5) Maintenance & Repair 6) Cleaning 7) Supplies 8) Security 9) Elevator Maintenance
What sources can be used for Vacancy and Collection Loss?
1) Management and leasing agents 2) Rent comparables 3) Sale comparables 4) Published surveys 5) History of the subject property
Reasons for High Expenses include....
1) Poor construction quality 2) Inefficient systems 3) Bad management resulting in high expenses
Reasons for a low Effective Gross Income (EGI) include...
1) Poor design 2) Inferior unit mix 3) Bad management resulting in low income 4) Below-market leases 5) Poor condition
What is the typical order of the levels of income, from largest to smallest amount?
1) Potential gross income 2) Effective gross income 3) Net operating income 4) Equity cash flow
Data Sources for Variable Expenses:
1) Published national industry surveys 2) Published local or regional surveys 3) Property managers 4) Real estate agents who specialize in a particular type of property 5) Subject property history 6) Published listings of comparable properties
Income characteristics of a lease...
1) Quantity: the amount of income stipulated in a lease 2) Quality: The credit strength of the tenant and the relationship of the contract rent to market rent determines the probability of collecting the income stipulated in the lease. 3) Durability: The term (length) of the lease establishes the period over which scheduled income can be expected to be received.
Sources of cost estimates for Replacement Allowance:
1) Subject property owner or manager 2) Cost manuals 3) Property managers 4) Comparable sales
Annuity (Definition):
A contract providing for regular payments of predictable amounts. Regular payments are those that occur at a constant period rate, such as monthly, quarterly, or annually. Predictable amounts include those that are level, that escalate based on the Consumer Price Index, that step up or that can be predicted in any other way.
What is the effective annual rate for 12% nominal rate payable bimonthly (six times per year)?
12.62% (using the formula for the effective interest rate)
What is the total number of mills for a 3.25% tax rate?
32.5 mills
A 5% tax rate is equal to how many mills?
50
Vacancy and Collection Loss (Definition)
A deduction from potential gross income (PGI) made to reflect income reductions due to vacancies, tenant turnover, and nonpayment of rent; also called "vacancy and credit loss" or "vacancy and contingency loss".
Master Lease (Definition)
A lease in which the fee owner leases a part or the entire property to a single entity (the master lessee) in return for a stipulated rent. The master lessee then leases the property to multiple tenants.
Ground Lease (Definition)
A lease that grants the right to use and occupy land. Improvements made by the ground lease typically revert to the ground lessor at the end of the lease term. The value of leased fee interest in a ground lease is sometimes equal to the value of the land, but it is not the same concept.
Reversion (Definition)
A lump-sum benefit that an investor receives or expects to receive at the termination or sale of an investment.
Direct Capitalization
A method used to convert an estimate of a single year's income expectancy into an indication of value in one direct step, either by dividing the net income estimate by an appropriate capitalization rate or by multiplying the income estimate by an appropriate factor. (under the definition, direct capitalization can involve either multipliers or capitalization rates, but it always involves converting a single year's income into value)
What is true about multipliers and cap rates?
A multiplier is usually greater than one and a capitalization rate is less than one.
Buyout Clause (Definition)
A provision for a payment by a landlord or a tenant to the other to induce a lease cancellation.
Escape Clause (Definition)
A provision of a contract that allows one or more parties to cancel all or part of the contract; sometimes called a kick-out clause when it allows a landlord to cancel a lease.
Ranking Analysis (Definition)
A qualitative technique for analyzing comparable sales; a variant of relative comparison analysis in which comparable sales are ranked in descending or ascending order of desirability and each is analyzed to determine its position relative to the subject.
Relative Comparison Analysis (Definition)
A qualitative technique for analyzing comparable sales; used to determine whether the characteristics of a comparable property are inferior, superior, or similar to those of the subject property. Relative comparison analysis is similar to paired data analysis, but no quantitative adjustments are derived.
Discount Rate
A rate of return on capital used to convert future payments or receipts into present value.
Millage (Definition)
A tax rate expressed as mills per dollar. For example, a 2% tax rate is $2 per $100, $20 per $1,000, or 20 mills per dollar.
What is the first thing to do in the best way to approach solving a problem involving components?
Decide between band of investment and residual
Band of Investment (Definition)
A technique in which the capitalization rates attributable to components of an investment are weighted and combined to derive a weighted-average rate attributable to the total investment (i.e. debt and equity OR land and improvements)
Pass-Through (Definition)
A tenant's portion of operating expenses that may be composed of common area maintenance (CAM), real property taxes, property insurance, and any other expenses determined in the lease agreement to be paid by the tenant.
Annuity in Advance (Definition)
A type of annuity in which cash flows are paid at the beginning of each period; also known as Annuity Due.
Ordinary Annuity (Definition):
A type of annuity in which cash flows are paid at the end of each period; also known as Annuity in Arrears.
What type of tax can be deducted from effective gross income to estimate net operating income?
Ad valorem property tax
Other Income (Definition)
All income generated in the operation of the property that is not derived directly from the space rental.
Replacement Allowance (Definition)
An allowance that provides for the periodic replacement of building components that wear out more rapidly than the building itself and must be replaced during the building's economic life.
The cash on cash rate is...
An equity capitalization rate
All capitalization methods require....
An estimate of first year's income
Equity Capitalization Rate (Re)
An income rate that reflects the relationship between one year's equity cash flow and the equity investment; also called the cash-on-cash rate, the cash throw-off rate, or the equity dividend rate.
What is deducted from net operating income to result in pretax cash flow?
Annual debt service
Projected market and contract rents are examples of...
Anticipation
The income capitalization approach is most often associated with...
Anticipation
Assessed Value (Formula)
Assessed Value = Market Value * Assessment Ratio
Band of Investment Model (Formula):
B x RB + L x RL = RO or , M x RM + (1 - M) x RE = RO
What subscripts are used to identify the components of Income, Rate, and Value in a land-building residual?
B, L, O
The technique in which the capitalization rates attributable to components of a capital investment are weighted and combined to derive a weighted-average rate attributable to the total investment is known as...
Band of investment model
When market participants agree that the sum of the values of the leased fee and leasehold equals that of the fee simple, what is a common way of adjusting the fee simple value conclusion for a multi-year, below-market lease?
Deduct the capitalized rent loss
A capital R is always used when...
Directly capitalizing a single year's income
In the land residual or building residual technique, what do the non-subscripted symbols B, L, and V stand for?
Building ratio, land ratio, and value amount
For a fully-amortized mortgage, for a known level payment over a known term at a known interest rate, what is a solution strategy for a problem asking for the loan amount?
Calculator white keys
If income is level over a specified projection period, what is a solution strategy for a problem asking for the income given a yield rate, property value and reversion?
Calculator white keys
Effective Rent (Definition)
Can be specified per year or per month
Net Operating Income (NOI)
Cap Rate = NOI / Value
The two common ways to calculate a reversion are trending up current value and....
Capitalizing future income
Multiple amounts of money are called....
Cash flows (CFs)
What is the result of the cause and effect relationship among the forces that influence real property value?
Change
What should you do if you appear to be missing information when solving a problem?
Check the problem to see if it gives some unused data. Then try to find a formula involving that data and that which appears to be missing.
What is the best way to choose a band of investment formula?
Choose the band of investment formula that has what is given on the right side of the equal sign and what you want on the left side.
What is an example of something that could cause utility costs for the subject property to vary from reported operating expense sources?
Climate
The six functions of One are factors based on....
Compounding interest
If an appraiser believes the sum of the values of the leased fee and leasehold equals the value of the fee simple in a particular instance (in other words, if VO = VLF + VLH), it should be a(n)....
Conclusion
What is true regarding vacancy and collection loss?
Consistency demands that if the comparable sales treat vacancy and collection loss in the rate, then the subject should be treated similarly.
Discounting (Definition)
Conversion of benefits received in the future (i.e. periodic incomes, cash flows, reversion) to present value.
What measures the ability of a property to meet its debt service out of net operating income?
Debt coverage ratio
What ratio do lenders sometimes use as a loan-constraining factor?
Debt coverage ratio
Leaseholds are usually valued using...
Discounted cash flow
What is the procedure used to convert periodic incomes and reversions into present values is...
Discounting
A capital Y is always used when...
Discounting all the income over the projection period
A flat rental lease is one that...
Does not adjust throughout the lease term
The estimated percentage of potential gross income (PGI) that will NOT be collected due to lack of occupancy in a building is....
Economic vacancy
Effective Annual Interest Rate (Formula)
Effective Annual Interest Rate = (1 + (i / n))^n - 1
Variable expenses are deducted from...
Effective Gross Income (EGI)
Effective Tax Rate (Formula)
Effective Tax Rate = Property Taxes / Market Value
Fixed expenses are deducted from...
Effective gross income (EGI)
The ratio between the sale price (or value) of a property and its effective gross income is the...
Effective gross income multiplier
The projected property tax as a percent of market value is...
Effective tax rate
The operating expense ratio is....
Equal to the total operating expenses divided by the effective gross income (EGI)
Instead of income being split between land and building in equity residual problems, it is split between the mortgage cash flow (the annual debt service, or IM) and....
Equity cash flow
An income rate that reflects the relationship between one year's equity cash flow and the down payment refers to...
Equity dividend rate
The internal rate of return on equity capital refers to...
Equity yield rate
Examples of Master Leases...
Executive office suites, where a company will lease an entire floor of an office building, and then lease single offices to individual tenants and include office services such as reception and conference rooms.
Market rent is used exclusively when valuing...
Fee simple
What describes the most complete interest in a property?
Fee simple
Which of the division of rights would be applicable to a mortgage and equity residual?
Financial
The amount of vacant space that is needed in a market for its orderly operation...
Frictional vacancy
For an income definitional question involving a text answer, you should choose...
The best answer
PV reversion corresponds to the right to...
Get the property back at the end of the lease
A lease in which the landlord pays all operating expenses is...
Gross
When using which direct capitalization rate or multiplier is it more important to consider the operating expense ratio?
Gross income multiplier
What non-subscripted symbols are used to identify the components of Income and Value when valuing residual estates created by a lease?
I and V
IO = what + IE?
IM
For a level-payment mortgage, for a known amount with a known mortgage capitalization rate, what is a solution strategy for a problem asking for a loan payment?
IRV formula
For a property with a known first year income and known capitalization rate, what is a solution strategy for a problem asking for value?
IRV formula
For a property with a known first year income and known value, what is a solution strategy for a problem asking for capitalization rate?
IRV formula
Which is an acceptable method for handling leasing commissions in direct capitalization?
Implicity in the rate from the comparable sales applied to the subject property
What is the best way to determine if a breakpoint is natural?
In the lease, compare the sales breakpoint to the base rent divided by the stated percentage; if it is equal, then the breakpoint is natural.
I is always used to refer to...
Income
PV income corresponds to the right to receive...
Income
The economic components into which a property can be divided refers to...
Income stream and reversion
What are two components of annual debt service (Im)?
Interest and principal paydown
The annualized yield rate or rate of return on capital that is generated or capable of being generated within an investment or portfolio over a period of ownership is the...
Internal rate of return
Reimbursement (Definition)
Involves operating expenses that are charged back to the tenant, often on the basis of the proportion of space the tenant occupies compared to the total. The reimbursement is made to the owner for expenses paid by the owner and it represents additional rent or income. Reimbursements are common in office building and shopping center leases, and in apartment buildings where utility sub-metering is not feasible.
If your HP-12C begins displaying a flashing "*" during the exam, the battery...
Is likely to last for at least several days after the exam
Multipliers Formulas...
Multipliers: V = I x F where "I" is any type of income and "F" is the corresponding factor, or multiplier
Yield capitalization disadvantages are that more judgment is required to support conclusions, as well as...
It is not acceptable in some courts of law
In a fixed rate, level payment, fully amortizing loan... How, if at all, does the principal portion of each payment change over the life of the loan?
It rises
What subscripts are used to identify the components of Income, Yield, and Value when valuing residual estates created by a lease?
LF and LH
Who is protected by an expense stop?
Landlord
What interest typically sells with a fully leased office building?
Leased fee
What word describes the landlord's position?
Leased fee
Band of investment and residual problems always divide the total property value between building and land, or mortgage and equity, or....
Leasehold and leased fee
Retail Green Leases (Definition)
Leases written on green buildings (LEED, Green Globe, etc.), which often include terms that provide monetary incentives and tax benefits.
The division of property into leasehold and leased fee represents the...
Legal category
What technique can be used when appraising a property located in a jurisdiction where assessed values can be expected to rise to reflect market value upon a sale?
Load the overall capitalization rate
Which is a common way for leasing commissions to be handled for an unoccupied building in direct capitalization?
Lump-sum deduction from capitalized income as though occupied
What is the symbol for loan-to-value ratio?
M
What subscripts are used to identify the components of Income, Rate, and Value in a mortgage-equity residual?
M, E, O
What refers to a concern with applying a residual technique to the legal components?
Market data have shown that the sum of the values of the leasehold and leased fee frequently is not equal to the value of the fee simple.
The most probable rent that a property should bring in a competitive and open market, reflecting all conditions and restrictions of a typical lease agreement is....
Market rent
The type of rent used for vacant and owner-occupied space....
Market rent
When valuing the fee simple interest in a leased property, potential gross income is based on...
Market rent for all space
What does "Rm" represent in the formula relating Ro and the components RM and Re?
Mortgage capitalization rate
What is not one of the "six functions of One", but is a related factor that always expresses the total loan payment per year for a $1 loan based on the nominal interest rate?
Mortgage capitalization rate
What refers to the capitalization rate for debt?
Mortgage constant
What is the reciprocal of the overall capitalization rate?
Net Income Multiplier (NIM)
The relationship between price or value and net operating income expressed as a factor or the reciprocal of the overall [capitalization] rate is...
Net income multiplier
To what line do "above-the-line" expenses refer?
Net operating income
For direct capitalization, vacancy and collection loss generally applies to what year's potential gross income?
Next year's
Mortgage Capitalization Rate (Formula):
One year's income divided by the balance of the mortgage.
Fixed Expenses (Definition)
Operating expenses such as property taxes and insurance that generally do not vary with occupancy and which prudent management will pay whether the property is occupied or vacant.
An appraiser projected a property's next-year net operating income. What rate should be used to convert this amount into value?
Overall capitalization rate
Present Value Factor (Formula):
PV Factor = 1 / (1+i)^n
PV Income + PV reversion = ?
PV Whole property
What is a standard characteristic of an annuity?
Payments must occur in regular predictable amounts
The amount of available space, either in a property or a market is...
Physical vacancy
Vacancy and collection loss is deducted from...
Potential Gross Income (PGI)
Which Function of One describes the Inwood Factor?
Present value of one per period
In the expression "return on and return of", what is expected to be returned?
Principal
Residual Techniques (Definition)
Procedures used to capitalize the income allocated to an investment component of an unknown value after all investment components of known values have been satisfied; may be applied to a property's physical components (land and building), financial interests (mortgage and equity), legal components (leased fee and leasehold interests), or economic components (income and reversion).
Property Taxes (Formula)
Property Taxes = Assessed value * Tax Rate
If a problem mentions land and building components OR mortgage and equity components, it is probably either a band of investment or ...
Residual problem
How can a band of investment problem be distinguished from a residual problem?
Residual requires knowing the value of one of the components while a band of investment uses the proportional distribution between the components
A lump sum-benefit that an investor receives or expects to receive at the termination of an investment is the...
Reversion
Which formula represents the relationship between the overall capitalization rate and the debt coverage ratio (DCR)?
Ro = M x Rm x DCR
Tax Rate (Formula)
Tax Rate = Mill Rate / 1,000
Quantitative Techniques (Definition)
Techniques used to derive quantitative adjustments to comparable sale prices in the sales comparison approach; also used in the development of adjustments in other valuation approaches and techniques.
Who is protected by an expense cap?
Tenant
What is an example of an expense that is often shown "below the line"?
Tenant improvements or Leasing Commissions
Market Vacancy (Definition)
The actual amount of vacant space in a market at a specified point in time; measured either as an amount or as a percentage of total supply. Market vacancy changes over time as a result of changes in the balance of supply and demand.
Net Operating Income (Definition)
The actual or anticipated net income that remains after all operating expenses are deducted from effective gross income, but before mortgage debt service and book depreciation are deducted.
Frictional Vacancy (Definition)
The amount of vacant space needed in a market for its orderly operation. Frictional vacancy allows for move-ins and move-outs.
Internal Rate of Return (IRR)
The annualized yield rate or rate of return on capital that is generated within an investment or portfolio over a period of ownership.
Effective Gross Income
The anticipated income from all operations of the real estate after an allowance is made for vacancy and collection losses, and an addition is made for any other income.
Terminal Capitalization Rate (Rn)
The capitalization rate (usually) applied to the expected net operating income for the year immediately following the end of the projection holding period to derive the resale price or value of a property. Also called a going-out or reversionary capitalization rate. Often a terminal capitalization rate is expressed in terms of basis points over the initial, or going-in capitalization rate, with 100 basis points comprising one percentage point.
Mortgage Capitalization Rate (Rm)
The capitalization rate for debt; the ratio of the annual debt service to the principal amount of the mortgage loan. The mortgage capitalization rate (Rm) is equivalent to the periodic (monthly, quarterly, annual) mortgage constant times the number of payments per year on a given loan on the day that the loan is initiated.
The overall capitalization rate is the weighted average of...
The cash on cash rate and the mortgage capitalization rate
Capitalization (Definition)
The conversion of income into value
To whom does the benefit of low property taxes accrue in a jurisdiction that is prevented from increasing assessed values faster than a fixed low rate, unless the property sells?
The current owner
Who is protected by an expense stop and who is protected by an expanse cap?
The expense stop protects the landlord and the expense cap protects the tenant.
Potential gross income based on market rents is used for...
The fee simple interest
In a ground lease, improvements made to the land typically revert to...
The ground lessor
Potential gross income based on contract rents is used for...
The leased fee interest
Safe Rate (Definition)
The minimum required rate of return on invested capital. Theoretically, the difference between the total rate of return and the safe rate is considered a premium to compensate the investor for risk, the burden of management, and the illiquidity of the capital invested. Safe rate is also called the "riskless rate" or the "relatively riskless rate"
The rate of return on debt capital refers to...
The mortgage interest rate
Variable Expenses (Definition)
The operating expenses that generally vary with the level of occupancy or the extent of services provided.
Operating Expenses (Definition)
The periodic expenditures necessary to maintain the real estate and continue production of the effective gross income, assuming prudent and competent management.
After Tax Cash Flow (ATCF)
The portion of pre-tax cash flow that remains after all income tax liabilities have been deducted.
Green Building (Definition)
The practice of creating structures and using processes that are environmentally responsible and resource-efficient throughout a building's life cycle from sitting to design, construction, operation, maintenance, renovation, and deconstruction. This practice expands and complements the classical building design concepts of economy, utility, durability, and comfort.
How would you describe the reversion factor?
The present value of One
Which two financial functions of One are reciprocals of each other?
The present value of One and the future value of One
The sum of the leasehold and leased fee is often less than the fee simple when...
The property is not improved to its highest and best use if vacant
What does B represent in the formula "RO = L × RL + B + RB"?
The proportion of value attributable to building
What does "M" represent in the formula relating Ro and the components Rm and Re?
The proportion of value attriubutable to the mortgage (also called the loan-to-value ratio)
Equity Yield Rate (Ye)
The rate of return on the equity capital invested
Overall yield rate (Yo)
The rate of return on the total capital invested, including both debt and equity. Also called the property yield rate. When applied to cash flows, it is called a discount rate.
Interest Rate
The rate of return, or yield, on debt capital. Abbreviated "i", or Ym
Effective Gross Income Multiplier (EGIM)
The ratio between the sale price (or value) of a property and its annual effective gross income.
Potential Gross Income Multiplier (PGIM)
The ratio between the sale price (or value) of a property and its annual potential gross income.
Debt Coverage Ratio (DCR)
The ratio of net operating income to annual debt service, which measures the relative ability of a property to meet its debt service out of net operating income; also called the debt service coverage ratio. (DSCR)
Overall Capitalization Rate (Ro)
The relationship between a single year's net operating income expectancy and the total property price or value.
Net Income Multiplier (NIM)
The relationship between price (or value) and net operating income expressed as a factor; the reciprocal of the overall capitalization rate. This multiplier is somewhat analogous to price/earning ratios used to value common stock.
Gross Rent Multiplier (GRM)
The relationship or ratio between the sale price or value of a property and its periodic gross rental income. (Gross RENT multipliers exclude other income and can be calculated on a monthly or annual basis. However, gross INCOME multipliers include other income and typically are calculated on an annual basis, only.)
Leasehold capitalization rates are difficult to find and when available, they are highly impacted by the terms and conditions of the lease, the differential between market and contract rents, and especially...
The remaining term on the lease
For a residual problem, use IRV and....
The rule that the sum of the parts equals the whole any time we have two numbers and need a third.
What determines how CAM reimbursements are calculated?
The signed leases
Total Operating Expenses (Definition)
The sum of all fixed and variable operating expenses and the replacement allowance cited in the appraiser's operating expense statement. [These are deducted from effective gross income (EGI) to arrive at net operating income (Io).]
What is an instance, if any, when the overall capitalization rate and the property yield rate are equal?
They are equal when no change in income or value is projected over the holding period.
What is the typical relationship between an overall cap rate extracted from sales comparables and the overall cap rate developed with the debt coverage ratio model?
They are often NOT equal for various reasons
What is the relationship between a capitalization rate and a multiplier?
They both relate income to value but in different ways
How are tests of reasonableness for operating expenses helpful?
They can support weighing one comparable sale's multiplier more than another and the accuracy of expenses estimated for the subject property can be evaluated.
An effective gross income multiplier and a net income multiplier are extracted from one sale and applied to the subject property, producing two somewhat different answers. This was most likely caused by a difference in....
Total expenses
The sum of the parts can be greater than the whole when...
Unaware and/or uninformed buyers who do not understand or refuse to accept that leasehold values decline, especially near the end of the lease.
In equity residual problems, total property value VO is split between the value of the mortgage, or loan amount VM, and this....
VE
VO = VM + what?
VE
Economic Vacancy (Definition)
Vacancy expressed as a percentage of potential gross revenue. For a property with a mix of rental rates, the physical vacancy rate and the economic vacancy rate may not be the same if spaces with higher or lower rental rates have disproportionate amounts of vacancy. Economic Vacancy Rate = Total Rent lost due to Vacant Space / Total potential gross revenue
Physical Vacancy (Definition)
Vacancy expressed as an amount or ratio based on a physical measurement. (i.e. Vacant Units / Total Units)
Structural Vacancy (Definition)
Vacant space resulting from a change in the structure of a market. Examples: Occurs in a city dominated by a single employer or industry and that employer/industry contracts or leaves altogether. Structural vacancy can be expected in more than one property type, including retail and multi-unit housing.
With residual problems, the ______ and the proportional relationship is unknown.
Value of one of the components
V is always used to refer to...
Values
What is the symbol for the loan amount?
Vm
The sum of values is equal to...
Vo
Numerical distracters, or the wrong answers to a multiple choice level-income question often are....
What result from solving the question incorrectly
When will a yield rate and a capitalization rate be the same?
When there is no change in income or value over the holding period.
The mortgage interest rate represented by subscripting is...
Y
Is a mortgage interest rate ever equal to a mortgage capitalization rate?
Yes, for an interest-only loan
Should an appraiser check a proposed shopping center's leases?
Yes, for lessor/lessee signatures and for agreement with pro forma potential gross income (PGI).
Can the sales comparison approach be used to value a leased fee interest where the leases are below-market?
Yes, if the comparable sales on which the sales comparison approach is based have similar below-market leases
Can the cost approach be used to value a leased fee interest where the leases are below-market?
Yes, if the cost approach includes the cost of removing the tenants
Would it ever be appropriate to use a fee simple capitalization rate to value a leasehold?
Yes, if the remaining term of the lease was very long
Can the leased fee interest in a property with a below-market lease be valued using direct capitalization?
Yes, market rent can be capitalized using a capitalization rate derived from sales with near-market lease situations and then a deduction made for the below-market lease.
Is it possible for the sum of the leasehold and leased fee interests to be less than the value of the fee simple, and if so how?
Yes, with a lease limiting the use to the current use which is not the highest and best use
Which of the two general methods of income capitalization converts future benefits into present value?
Yield
Discounted cash flow is a type of...
Yield capitalization
Don't switch to the other technique (from band of investment to residual or vice versa) unless...
You have tried everything else
Common examples of Concessions:
- Free Rent - Above standard TI's - Buyout of tenant's existing lease - Below standard escalation clause - Naming rights for the building
Synonyms for the mortgage capitalization rate:
- Loan Constant - Mortgage Constant - Annual constant
Advantages of yield capitalization.:
1) Accommodates multi-tenant properties, where the leases are at different rent levels 2) Accommodates atypical income and expense patterns 3) Premises are explicit
What is usually true about capitalization rates and multipliers?
A capitalization rate is less than one and a multiplier is greater than one
Expense Cap (Definition)
A clause in a lease that limits a tenant's share of operating expenses
Expense Stop (Definition)
A clause in a lease that limits the landlord's expense obligation, which results in the lessee paying operating expenses above a standard level or amount.
Escalation Clause (Definition)
A clause in an agreement that provides for the adjustment of a price or rent based on some event or index (i.e. a provision to increase rent if operating expenses increase)
A capitalization rate and yield rate can be equal in two circumstances: When no change in income or value is projected over the holding period and....
A coincidence
Present value of One (Definition)
A compound interest factor that indicates how much $1 (or other unit of currency) due in the future is worth today. The Present value of One is also called the reversion factor.
Present Value of One per period (Definition):
A compound interest factor that indicates how much $1 (or other unit of currency) paid periodically is worth today.
Tenant Improvement Allowance or Tenant Improvements (TIs)
A dollar amount (usually expressed per square foot) provided to the tenant by the landlord for the construction of tenant improvement, which may or may not equal the cost of remodeling.
Inwood Factor (Definition):
A factor that reflects the present worth of $1 (or other unit of currency) per period for a given number of periods, discounted at a given discount rate. Inwood Factor is obtained by calculation or from standard compound interest tables and used to discount an annuity to present worth; also called the Inwood coefficient.
Sandwich Lease (Definition)
A lease in which an intermediate, or sandwich, leaseholder is the lessee of one party and the lessor of another. The owner of the sandwich lease is neither the fee owner nor the user of the property; he or she may be a leaseholder in a chain of leases, excluding the ultimate sub-lessee.
Percentage Lease (Definition)
A lease in which the rent or some portion of the rent represents a specified percentage of the volume of the business, productivity, or use achieved by the tenant.
Revaluation Lease (Definition)
A lease that provides for periodic rent adjustments based on the market rental rate of the space.
Graduated Rental Lease (Definition)
A lease that provides for specified changes in rent at one or more points during the lease term (i.e. step-up and step-down leases, or leases with a set percentage adjustment)
Flat Rental Lease (Definition)
A lease with a specified level of rent that continues throughout the term
Index Lease (Definition)
A lease, usually for a long term, that provides for periodic rent adjustments based on the change in an economic index.
Reversion (Definition)
A lump-sum benefit that an investor receives or expects to receive at the termination of an investment.
Direct Capitalization (definition)
A method used to convert an estimate of a single year's income expectancy into an indication of value in one direct step, either by dividing the income estimate by an appropriate capitalization rate or by multiplying the income estimate by an appropriate factor. Direct capitalization employs capitalization rates and multipliers extracted or developed from market data. Only one year's income is used. Yield and value change are implied, but not explicitly identified.
Yield Capitalization (definition)
A method used to convert future benefits into present value by (1) discounting each future benefit at an appropriate yield rate, or (2) developing an overall rate that explicitly reflects the investment's income pattern, building period, value change, and yield rate.
A capitalization rate is used to convert...
A single year's income into value
Nominal Interest Rate (Definition)
A stated or contract rate; An interest rate, usually annual, that does not necessarily correspond to the effective or compound interest rate. The nominal interest rate is the periodic interest rate multiplied by the number of compounding periods per year. This is an annual interest rate.
Fee Simple Estate (Definition)
Absolute ownership unencumbered by any other interest or estate, subject only to the limitations imposed by the governmental powers of taxation, eminent domain, police power, and escheat.
Equity Cash Flow (Ie)
Also known as pre-tax cash flow (PTCF)... it is the portion of Net Operating Income that remains after total mortgage debt service is paid but before ordinary income tax on operations is deducted.
Renewal Option (Definition)
An agreement entered into at the time of the original lease providing the right, but not the obligation, for the tenant to extend the lease term for a specified time and at the rent specified in the option agreement or at the market rate at the time of renewal.
Concession (Definition)
An inducement for a tenant to lease space, most often observed in overbuilt markets.
An annuity with payments at the end of each period is called....
Annuity in arrears (aka ordinary annuity)
Capitalization rate (R) and yield rate (Y) have different symbols because they...
Are different concepts
Periodic interest rate is synonymous with....
Effective rate
The rental rate, per year or per month, net of financial concessions such as periods of no rent during the lease term is known as....
Effective rent
Future Value Factor (Definition)
FV Factor = (1+i)^n
Contract rent prior to a deduction for concessions....
Face Rent
What is the one estimate that is common to both discounted cash flow analysis and direct capitalization?
First year's income
What describes the sinking fund accumulation factor?
Future value of One per period
The compound interest factor that indicates the amount to which One will grow with compound interest at a specific rate for a specified number of periods is....
Future value of one
Escalation Income (Definition)
Income generated from a lease clause that increases the income payable to the landlord above that payable in the base term.
Identify the function by the method listed below used to extract its value from the HP-12C calculator: "1 in PV Solve for PM"
Installment to amortize One
When valuing the leased fee interest using direct capitalization, name one of the two options that an appraiser has for potential gross income...
Potential gross income is based on market rent and capitalized with a rate derived from sales with market rents, and then a deduction is made for the discounted difference in contract and market rent.
What is the symbol for the annual constant?
Rm
PV of One per period factor (Formula):
See Module 3.5
Sinking Fund Factor (Formula):
Sinking Fund Factor = i / ((1+i)^n - 1)
Contract Rent (Definition)
The actual rental income specified in a lease
Excess Rent (Definition)
The amount by which contract rent exceeds market rent at the time of the appraisal
Deficit Rent (Definition)
The amount by which market rent exceeds contract rent at the time of the appraisal
Annual Debt Service (Im)
The annual sum of the periodic payments called for in a mortgage contract.
Effective Gross Income (EGI)
The anticipated income from all operations of the real property after allowance is made for vacancy and collection losses and an addition is made for any other income.
Mortgage Capitalization Rate (Rm):
The capitalization rate for debt; the ratio of the annual debt service to the principal amount of the mortgage loan. The mortgage capitalization rate is equivalent to periodic (monthly, quarterly, annual) mortgage constant times the number of payments per year on a given loan on the day the loan is initiated.
Sinking Fund Factor (Definition):
The compound interest factor that indicates the amount per period that will grow, with compound interest, to $1 (or other unit of currency). It is also known as the periodic payment to grow to One and sometimes as the acronym SFF.
Amount of One per period (Definition):
The compound interest factor that indicates the amount to which $1 (or other unit of currency) per period will grow with compound interest at a specified rate for a specified number of periods. Also called the sinking fund accumulation factor or future value of one per period.
Amount of One (Definition):
The compound interest factor that indicates the amount to which $1 (or other unit of currency) will grow with compound interest at a specified rate for a specified number of periods. The amount of one is one of the six functions of one found in standard financial tables; also called future value of one.
The installment to amortize One (Definition):
The compound interest factor that represents the installment needed to repay one unit of currency with interest at a specified rate for a specified number of periods; the reciprocal of the level annuity factor. Also called the partial payment factor or amortization factor.
Compound Interest (Definition)
The continuous and systematic additions to a principal sum over a series of successive time periods so that previously earned interest earns interest.
Face Rent (Definition)
The contract rent prior to deduction of concessions; also known as nominal rent.
Breakpoint (Definition)
The level of sales at which a percentage clause in a lease is activated
Natural Breakpoint (Definition)
The level of sales at which the percentage rent equals the base rent as specified in a lease. It can be calculated by dividing base rent by the stated percentage.
The periodic or effective interest rate multiplied by the number of compounding periods per year is...
The nominal interest rate
Leased Fee Interest (Definition)
The ownership interest held by the lessor, which includes the right to receive the contract rent specified in the lease plus the reversionary right when the lease expires. Also called leased fee estate, with the rights of use and occupancy conveyed to others.
Overage Rent (Definition)
The percentage rent paid over and above the guaranteed minimum rent or base rent; calculated as a percentage of sales in excess of a specified sales volume.
Periodic Interest Rate (Definition)
The rate applied to the investment from period to period. (i.e. the interest rate per compounding period, or "i")
Effective Annual Interest Rate (Definition)
The rate that includes the effects of compounding. This is also an annual interest rate but has a different formula. If z is the number of compounding periods per year, and "i" is the periodic interest rate, the formula is (1+i)^z -1. Note that this formula is different from that for a nominal interest rate, and the two rates produce equal results only when the compounding period is annual (z = 1).
Percentage Rent (Definition)
The rental income received in accordance with the terms of a percentage lease. (Typically derived from retail store and restaurant tenants and based on a percentage of their gross sales).
Leasehold Interest (Definition)
The right held by the lessee to use and occupy real estate for a stated term and under the conditions specified in the lease. Also called leasehold or leasehold estate
Gross Lease
The tenant pays a stated rent every month, and the landlord pays all operating expenses including utilities. (in some markets, full service gross is synonymous with gross. In others, it can mean that the tenant only pays those expenses that exceed base-year expenses.)
Time Value of Money (Definition)
The time value of money is the concept underlying compound interest that holds that $1 (or another unit of currency) received today is worth more than $1 (or another unit of currency) received in the future due to opportunity cost, inflation, and the certainty of payment.
Effective Rate (Definition)
The total base rent, or minimum rent stipulated in a lease over the specified term minus rent concessions; the rent that is effectively paid by a tenant net of financial concessions provided by a landlord.
Potential Gross Income (PGI)
The total income attributable to property at full occupancy before vacancy and operating expenses are deducted.
Future Value (FV):
The value of the account at the end of the holding period. FV = PV x (1 + i)^n
Present Value (PV)
The value of the account when it is opened.
How are replacement allowances, annualized tenant improvements, and annualized leasing commissions handled on an operating statement?
They are sometimes deducted as operating expenses depending on property type and market area.
What is an important reason for considering market value when applying the income capitalization approach?
To contrast it with investment value
What are the five components of the financial keys on the HP-12C calculator?
n, i, PV, PMT, and FV
