Chapter 15 Valuation Analysis: Income Discounting and Cap Rates

1
Chapter 15 Valuation Analysis Income
Discounting and Cap Rates
2
Major Topics

• Simple multiplier models of value
• The income approach to value
• The derivation of a capitalization rate
• Overall market rate capitalization

3
Value

• Value of any asset PV of expected future CFs
• Estimating expected future CFs?
• Holding period?
• Financing terms?
• Simplifications
• Capitalize to convert future income into a
  present value
• Gross Rent Multiplier
• Capitalization Rate

4
Reconstructed Operating Statement

• PGI Potential Gross Income
• Vac Vacancy Allowance
• MI Miscellaneous Income
• EGI Effective Gross Income
• OE Operating Expenses
• NOI Net Operating Income
• NOI EBITDA

5
Gross Rent (PGI) Multiplier

• GRM (Gross Rent Multiplier)
• Price / Gross Rent (PGI)
• Quick indicator of value for smaller rental
  properties
• Presumption Whatever investors are willing to
  pay for similar property per dollar of gross rent
  they should be willing to pay for a subject
  property
• GRM should be found from comps with
• Similar ages, turnover, growth projections

6
GRM Example ? PGI 162K
Value of subject
5.53 x PGI
5.53 x 162,000
895,860
7
Capitalization Rate

• Cap Rate NOI1 ? P0
• Similar to reciprocal of PE Ratio (P0 ? EPS1),
  except pre-tax
• Why do PE ratios differ across stocks?
• Cap Rates should be similar for similar
  properties

8
Cap Rates and Required Return

• P0 D1 (r g)
• Flip and solve for r
• r D1/ P0 g
• g expected growth expected cap gain yield
• D1/ P0 Dividend yield
• Flip again
• D1/ P0 r g
• Cap rate D1/ P0 r g
• What influences cap rates?

9
What influences cap rates?

• Economic conditions
• Market conditions ? S D of/for similar
  properties
• Type of property
• Age of property

10
Real Estate Principles for the New Economy
Norman G. Miller and David M. Geltner
11
Sources of Cap Rates

• RealtyRates.com www.realtyrates.com
• Other appraisers and market participants

12
Capitalization Rate

• If we know market Cap Rate, and we estimate NOI1,
  we have an estimate of market value of property.
• Buying apartment complex
• Cap Rate on San Marcos apartments 8
• Expect NOI1 to be 85,000.
• How much to bid?

13
Capitalization Rate

• Cap Rate NOI1 ? V0
• V0 NOI1 ? Cap Rate
• V0 85,000 ? 0.08
• V0 1,062,500
• Austin market rents increase faster ? what
  should change?
• Lower expected inflation ? what should change?

14
END