Property Property ValuationValuation

Dr. Arthur C. Nelson, FAICPDr. Arthur C. Nelson, FAICP

February 2010February 2010

OverviewOverview• Market Comparison Approach• Cost Approach• Income Approach• Rules of Thumb• Ratio Analysis

Market Comparison ApproachMarket Comparison Approach

You want to buy a 10 unit apartment.How much should you pay?

Cost ApproachCost Approach• Cost to replace or reproduce

– Variety of methods to estimate

• - Depreciation– Physical deterioration– Functional obsolescence– Economic obsolescence

• + Land value

Income ApproachIncome Approach

V = I/RV = I/RV = ValueV = ValueI = Net Operating Income, NOII = Net Operating Income, NOIR = Capitalization RateR = Capitalization Rate

StepsSteps Potential Gross Income (PGI)- Vacancy, Bad Debt Allowance (VBD)+ Miscellaneous Income (MI) Effective Gross Income (EGI)- Operating Expenses (OE) Net Operating Income (NOI)÷ Capitalization Rate (R, or Cap Rate)= Market Value

Example ApplicationExample Application

PGI $ 80,640VBD - 4,032MI + 1,000EGI $ 77,608OE - 29,100NOI $ 48,508R @ 0.0971 (or 9.71) = $499,500R @ 0.1075 (or 10.75) = $451,200

Rules of ThumbRules of ThumbOverall Capitalization Rate

R = NOI/VR = NOI/VNet Income Multiplier

NIM = V/NOINIM = V/NOIGross Income Multiplier

GIM = V/PGI or V/EGIGIM = V/PGI or V/EGIEquity Dividend Rate, “Cash on Cash”

EDR = BTCF / EquityEDR = BTCF / Equity

Before Tax Cash FlowBefore Tax Cash Flow

Cash on CashCash on Cash

Purchase Price $500,000Equity @ 30% $150,000BTCF $ 4,273EDR, Cash on Cash 2.85%

Ratio AnalysisRatio Analysis

Loan to Value Ratio

Mortgage Amt / Value, orMortgage Amt / Value, or

Mort. Outstanding / ValueMort. Outstanding / ValueDebt Coverage Ratio

DCR = NOI/DSDCR = NOI/DSDefault Ratio

DR = (OE + DS) / EGIDR = (OE + DS) / EGIOperating Expense Ratio

OER = OE / EGIOER = OE / EGI