A 12 story office building is proposed for the downtown area. This area is fully developed except for the subject site which is a surface parking lot. The proposed building with 120,000 SF is estimated to cost $10,800,000 and the property should generate a net operating income of $1,840,000 when complete and occupancy has stabilized. Investors in this type of development currently require a 9.00% rate of return. The building is estimated to have a 50 year economic life. The effective tax rate is 3.00%. The sinking fund factor at the safe rate of 3% for 50 years is .008865. The annuity factor at 9% for 50 years is .091227.
Solve for the value of the value of the property using straight line recapture, sinking fund recapture and annuity capitalization method.
Straight Line Recapture
Sinking Fund Method
Building Residual Technique Challenge
The subject property is an older two story retail building in a center city area currently experiencing rehabilitation and increasing land values. Due to this activity, land value has been estimated at $150,000 based on comparable sales. The property currently generates a net operating income of $65,000. The discount rate extracted from the market for this property type is 8.0% while the remaining economic life of the building is estimated at 25 years. The effective tax rate is 3.15%. The sinking fund factor at the safe rate of 3% for 25 years is .027428. The annuity factor at 8% for 25 years is .093679.
Solve for the value of the value of the property using straight line recapture, sinking fund recapture and annuity capitalization method.
Straight Line Recapture
Sinking Fund Method
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Land Residual Technique Challenge Solution Straight Line Recapture
Straight Line Building Capitalization Rate
Discount Rate .090000
Recapture Rate .020000
Effective Tax Rate .030000
Building Capitalization Rate .140000 Straight line 1/50 yr. REL
Straight Line Method
Income
Rate
Value
Building $1,512,000 14.00% $10,800,000
Land
$328,000
12.00%
$2,733,333
Total
$1,840,000 13.60% $13,533,333
Sinking Fund Method
Discount Rate .090000
Recapture Rate .008865
Effective Tax Rate .030000
Building Capitalization Rate .128865 SFF at 3% for 50 years
Sinking Fund Method
Income
Rate
Value
Building $1,391,747 12.8865% $10,800,000
Land
$448,253
12.0000%
$3,735,442
Total
$1,840,000
12.66%
$14,535,442
Annuity Method
Discount & Recapture .091227
Effective Tax Rate .030000
Building Capitalization Rate .121227 Annuity factor (PPMT) at 9% for 50 years
Annuity Method
Income
Rate
Value
Building $1,309,250 12.1227% $10,800,000
Land
$530,750
12.0000%
$4,422,917
Total
$1,840,000
12.09%
$15,222,917
Comparison of Methods Method Value Building Capitalization Rate Recapture Rate Straight-Line $13,500,000 .140000 .020000 Sinking-Fund $14,535,000 .128865 .008865 Annuity $15,223,000 .121227 .001227185
Building Residual Technique Challenge Solution Straight Line Recapture
Land Capitalization Rate
Discount Rate .08000
Effective Tax Rate .03150
Land Capitalization Rate .11150
Straight Line Building Capitalization Rate
Discount Rate .080000
Recapture Rate .040000
Effective Tax Rate .031500
Building Capitalization Rate .151500 Straight line 1/50 yr. REL
Straight Line Method
Income
Rate
Value
Building
$48,275
15.15%
$318,647
Land
$16,725
11.15%
$150,000
Total
$65,000
13.87%
$468,647
Sinking Fund Method
Land Capitalization Rate
Discount Rate .08000
Effective Tax Rate .03150
Sinking Fund Building Capitalization Rate
Discount Rate .080000
Recapture Rate .027428
Effective Tax Rate .031500
Building Capitalization Rate .138928 Straight line 1/50 yr. REL
Sinking Fund Method
Income
Rate
Value
Building
$48,275
13.893%
$347,482
Land
$16,725
11.15%
$150,000
Total
$65,000
13.07%
$497,482
Annuity Method
Land Capitalization Rate
Discount Rate .08000
Effective Tax Rate .03150
Land Capitalization Rate .11150
Discount & Recapture .093679
Effective Tax Rate .031500
Building Capitalization Rate .125179 Annuity factor .93678 (PPMT) at 8% for 25 years
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Annuity Method
Income
Rate
Value
Building
$48,275
12.5179%
$385,648
Land
$16,725
11.15%
$150,000
Total
$65,000
12.13%
$535,648
Comparison of Methods Method Value Building Capitalization Rate Recapture Rate Straight-Line $13,500,000 .15150 .040000 Sinking-Fund $14,535,000 .13893 .02743 Annuity $535,648 .12518 .01368Problem: Reconstructed Operating History/Direct Capitalization
You are appraising a 50 unit apartment property for a pending assessment appeal. There are 30 one bedroom apartments (650 square feet) and 20 two bedroom apartments (800 square feet). Your survey of comparable rental properties indicate that a one bedroom apartment should lease for $450 per month and a two bedroom apartment has a market rent of $500 per month.
Vacancy and collection loss surveys indicate 8.0% annually to be the market vacancy rate. Miscellaneous income for the subject property is 3.00% of potential gross rental income on a stabilized basis. Your study of the market expense comparables and the subject's actual expenses indicate the following expense estimates:
Management Fee: 4.00% of effective gross income.
Administrative & Leasing: $200 per apartment unit annually. Utilities: 4% increase anticipated over last year’s levels.
Grounds Maintenance: 4% increase projected over last year’s levels. Building Maintenance: $0.75/square foot of total net rentable area Redecorating: $150 per apartment unit annually.
Insurance: 2% of effective gross income. Miscellaneous: $500 per year.
The market information you have gathered indicates that a reserve for replacement category is warranted. A reserve is estimated for the following items.
Stove $300
Refrigerator $400
Disposal $ 75
Carpeting $600 (one bedroom apartment) $800 (two bedroom apartment)
Appliances are estimated to have a useful life of 10 years and carpeting has an 8 year useful life.
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Three comparable apartment properties have sold in the past 2 years. The net operating income developed from each sale property was based on the purchaser's pro forma and included reserves for replacement and property taxes.
What overall rates are developed from these sales?
Sale 1 Sale 2 Sale 3
Number of Units 40 75 60
N. O. I. $ 118,450 $ 202,590 $ 179,160
Sale Price $1,220,000 $2,080,000 $1,830,000
Overall Rate __________ __________ __________ _______
The local millage rate is $55.00 per thousand of assessed valuation with a 50% level of assessment.
Reconstruct the income and expense statement for the subject property. What is the: Potential gross rental income?
Effective gross income?
Operating expenses?
Reserves for replacement?
What are the operating expense ratios and expenses per square foot for the past three years? What is the projected operating expense ratio including reserves for replacement? How does that ratio compare to prior years. What conclusions can you draw concerning the operating expenses?
Test your capitalization rate developed by market abstraction. Conventional financing available at a maximum 70% loan-to-value ratio, 8.00% interest rate, 10 year term and 25 year amortization (Mortgage Constant Rm = .092618). Equity dividend rates are trending at 10.00%.
191
Actual Income and Expense History
3 Years Ago 2 Years Ago Last Year
Rental Income $235,000 $244,200 $252,000
Miscellaneous Income 7,630 8,050 8,510
Vacancy & Credit Loss 21,385 23,930 21,420
EFFECTIVE GROSS INCOME $221,245 $228,320 $239,090 Expenses
Management Fee $ 9,620 $ 10,165 $ 10,680
Administrative & Leasing 7,457 10,562 9,808
Utilities 17,500 18,500 20,500 Grounds Maintenance 11,795 11,171 12,002 Building Maintenance 22,310 24,582 26,010 Redecorating 4,390 6,125 6,930 Insurance 4,870 4,985 5,160 Property Taxes 25,435 28,500 29,790 Miscellaneous 810 900 1,346
TOTAL OPERATING EXPENSES $104,187 $115,490 $122,226 NET OPERATING INCOME $117,058 $112,830 $116,864 Operating Expense Ratio _________ _________ ________ Expenses/Unit _________ _________ ________ Expenses/SF _________ _________ ________
Reconstructed Operating Statement
Potential Gross Rental Income $_______________
Less Vacancy/Collection Loss $_______________
Plus Miscellaneous Income $_______________
Effective Gross Income $_______________
Operating Expense Analysis Fixed Expenses ____________________________ $_______________ ____________________________ $_______________ Variable Expenses ____________________________ $_______________ ____________________________ $_______________ ____________________________ $_______________ ____________________________ $_______________ ____________________________ $_______________ ____________________________ $_______________ ____________________________ $_______________ Replacement Allowance ____________________________ $_______________ ____________________________ $_______________ Total Expenses $_______________
193
Solution: Reconstructed Operating History/Direct Capitalization
What overall rates are developed from these sales?
Sale 1 Sale 2 Sale 3
Number of Units 40 75 60 N. O. I. $ 118,450 $ 202,590 $ 179,160 Sale Price $1,220,000 $2,080,000 $1,830,000 Overall Rate __.0971____ __.0974___ ___.0979___ __.0975__ +ETR = .0275 .1250
Reconstruct the income and expense statement for the subject property. What is the: Potential gross rental income?
30 - 1 Bedroom (675 SF) @ $450 $ 13,500 20 - 2 Bedroom (800SF) @ $500 $ 10,000 $ 23,500 x 12 mos $282,000
Effective gross income?
Potential Gross Rental Income $282,000 Vacancy & Credit Loss ($282,000 x .08) 22,560 Miscellaneous Income ($282,600 x .03) 8,460
$ 267,900
Operating expenses? $ 103,188
Reserves for replacement? $ 8,125
What are the operating expense ratios and expenses per SF for the past three years? What is the projected operating expense ratio including reserves for replacement? How does that ratio compare to prior years. What conclusions can you draw concerning the operating expenses?
3 yrs. Ago 2 yrs. Ago Last Year Projection
OER 35.59% 38.10% 38.66%' 38.52%
Expenses/Unit $1,575 $1,740 $1,849 $2,064
Expenses/SF $2.17 $2.40 $2.55 $2.85
Test your capitalization rate developed by market extraction. Conventional financing available at a maximum 70% loan to value ratio, 8.00% interest rate, 10 year term and 25 year amortization (RM = .092618). Equity dividend rates are trending at 10%.
.70 X .092618 = .064832
.30 X .100000 = .030000
.094832 9.48%
What is the indicated value of the subject property?
NOI $164,712 = $1,317,696 or $1,320,000
If reserves for replacement were excluded, what would be the indicated value? NOI $172,837 (w/o reserves) = $1,382,696 or $1,385,000
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Reconstructed Operating Statement
Potential Gross Rental Income $ _282,000_ Less Vacancy/Collection Loss (8.0% of PGI) $_ _22,560_
Plus Miscellaneous Income {3.00% of PGI) $____ _+8,460_
Effective Gross Income $__ _267,900_
Operating Expense Analysis Fixed Expenses
_____ Real Estate Taxes (use ETR)__________ $ 0_ ______ Insurance (2.00% of EGI)____________ $_ 5,358_
Variable Expenses
___ Management Fee (4.00% of EGI)_________ $_ 10,716_ ___ Administrative/Leasing ($200/unit )______ $_ _10,000_ ___ Utilities (last year x 1.04)_______________ $___ 21,320_ ___ Grounds Maintenance (last year x 1.04)___ $______ 12,482_ ___ Building Maintenance (36,250 X .75/SF)___ $______ 27,187_ ___ Redecorating ($150/unit)________________ $______ 7,500_ ___ Miscellaneous _________________________ $_____ 500_
Replacement Allowance
___ Appliances ($775/unit /10 yrs.)___________ $______ 3,875_ ___ Carpeting __________________________ $______ 4,250_ [(30 x $600/unit) + (20 x $800/unit) / 8 yrs]
Total Expenses $_____ 103,188_