Agenda - Council - 04/14/1981 - Laserfiche WebLink

Home

REAL ESTATE MARKET VALUE CONSIDERATIONS REAL ESTATE MARKET VALUE CONSIDERATIONS Fve been asked by Harry Yaffe to comment on some facets the appraisal process for income-producing investment real estate for members of NAIOP. This is a difficult subject because it seems nowadays that there is a wide range of differ- ences in appraisal techniques, formats and poss~l¥ estimates of market value resulting not only from variations in apprai- ser's expertise, but also rapidly chan~ing market conditions. Real estate investors are professionals who have a right to be confused at this point in time and space with the prevailing roller coaster-type of economy; and appraisers are confused as well in their attempts to understand what was, is, and what the future holds for incume.producing real estate. What follows is my point of view at this time concerning '"Internal Rates of Return" and its incorporation into an income approach to value. An internal rate of return by definition is the same as what is referred to as a "yield" rate and would also be the same as an interest rate on a direct reduction mortgage loan that was not discounted and held until fully amortized, say over 25 years. It is not a cash flow dividend rate which is calculated by dividing net income after debt ssr~ice by the equity investment. It is not an overall capitalization rate that is calculated by dividing the current estimate of net annual income before debt service by the total investment value or cost. So don't confuse capi- talizatinn rates, equity dividend rates, or yield rates (IRR). So why discuss internal rates of return? My answer is that IRR is one good explanation of the relationship between declining overall capitalization rates and declining equity dividend rates vs. greatly increased mortgage interest rates of the past in an investment climate that has to-date been one of increasing price inflation 'and perceived future infla- tion. For quality investment real estate, the inflationary component now makes up about 35% to 40~ of the total non-levaraged (unmortgaged) yield ORR). Non4evaraged real estate investments at overall capitalization rates of James D. Kramer, MAI, SRPA Kramer Appraisal Service, Inc. under 10% at this time by major financial institutions would seem to indicate a belief in a continuation of real estate inflation at recent past rates. Major institutional investors are using IRR to support real estate acquisitions and this is a major market consideration and should be considered in the appraisal process. The following is an example of how Kramer Appraisal Service, Inc. incorporates the unleveraged investment concept into an income approach to value. INTERNAL RATE OF RETURN VALUATION ANALYSIg (Example) In this income valuation analysis, the projected net annual income generated by the subject real estate before mortgage debt service, depreciation or income taxes is valued by dis- counting the respective future net income payments over a short-term projection period, representing a typical owner- ship period, by a factor which includes yields on and recap- ture of that portion of the real estate investment related to each individual future net income investment return. This part of the valuation process results in the present worth or market value of the series of net income payments over the projection period. In addition, the pre-tax proceeds resulting from the sale of the real estate at the end of the projection period is valued by discounting the future sales price at the same yield rate which is the internal rate of return with the discount factor related to the end of the last year of the projection period. This valuation analysis reflects an unlevar- aged ownership position for the real estate free and clear of encumbrances such ~s mortgage debt. The market value of the real estate estimated by this income approach to value is equal to the sum of the present worth of the series of net income payments and the present worth of the pre-tax pro- ceeds resulting from the projected future sale of the real estate at the end of the projection period. (cont. - over) Net Annual Income Projected for the End of Each Year of tbs Pr01ectlon Period Year One $133.500 X Year Two -- 133.500 X Year Thre~ 133,500 X Year Four 154,543 X Year FI~a 15z,,543 X Year Slx 154,543 X X VALUATION ANALYSIS 16.00~ Yield Rat~ (IRR) PresentWorth Factor for End of Each Respective Year : ~ Present Worth or Market Value of Each Future Net Investment Return 0:~621 $115.090 0,7432 - 99,217 0.6407 = 85,533 0.5523 85,354 0.4761 - . 73,578 0.4104 - 63.424 0.3538 - 63,296 0~050 - 54.565 0.2630 - 47.051 0.22~7 = 46,950 Tenth Year Net Salas Proceeds $1,958,000 X 0.2267 Total market value estimated for the subie=t property Rounded to say $ 443.879 $1,177,937 $1.175,000