Direct Capitalization

1
Direct Capitalization

• Jim Burton, Ph.D.
• Marketing Real Estate

2
Overview

• Income Streams
• Income Rates
• Derivation of Cap Rates
• Cap Rates from Comparable Sales
• Cap Rates from EGI
• Mortgage-equity analysis
• Debt Coverage Capitalization
• Residual Techniques

3
Income Streams

• Potential Gross Income
• Effective Gross Income (EGI)
• Net Operating Income (NOI)
• Before-Tax Cash Flow (BTCF)
• Land Income
• Building Income
• Leased Fee Income
• Leasehold Income

4
Income Rates

• Overall Cap Rate (OAR, Ro)
• RoNOI/Value or Price
• Mortgage Constant (Rm)
• Rm f (i, n)
• Equity Dividend Rate (Re)
• ReBTCF/Equity or Cash down

5
Derivation of Cap Rates

• From comparable sales
• EGI Net Income Ratios
• Mortgage-equity analysis
• Debt coverage formula
• Residual Techniques
• Yield Capitalization (Ellwood)

6
Cap Rates from Comparable Sales

• Sales of similar properties age, condition,
  size, location, etc.
• Similar income expense patterns
• Current market terms or cash equivalency
• Adjust for differences to subject property

7
Cap Rates from EGI

• Estimate EGIM from sales
• Operating expense ratio (OER)
• Net income ratio (NIR)
• NIR1-OER
• Sales should have similar NIRs
• RoNIR/EGIM

8
Mortgage-equity analysis

• Rm LTV ratio (10, 25 yrs)
• Ye Equity ratio
• Sum weighted rates
• 0.109 75 0.0818
• 0.12 25 0.0300
• Ro 0.1118
• Rounded 11.2 OAR

9
Debt Coverage Capitalization

• RoDCRRmLTV ratio
• Ro1.200.10975
• Ro0.981
• Ro9.8 rounded

10
Residual Techniques

• Building Residual
• Land Residual
• Mortgage residual
• Equity Residual

11
Building Residual

• Land Value 200,000
• NOI 67,500
• Less Income to land
• 9200,000 18,000
• Income to Bldg.49,500
• Bldg. Value
• 49,500/.11 450,000
• Total Value 650,000

12
Land Residual Technique

• Building Value 450,000
• NOI 67,500
• Less income to bldg.
• 450K.11 49,500
• Inc. to Land 18,000
• Land Value
• 18,000/9 200,000
• Total Value 650,000