The Student Handbook toTHE APPRAISAL OF REAL ESTATE

1

Chapter 22

Direct Capitalization

Student Handbook to THE APPRAISAL OF REAL ESTATEChapter 22 2

Capitalization Rates

The ratio of the sale price to the expected net income for the next year

May be extracted from comparable sales Other methods can be used to support

capitalization rate

Student Handbook to THE APPRAISAL OF REAL ESTATE

Derivation of Overall Capitalization Rates

From comparable sales RO = NIR/EGIM

By band of investment Mortgage and equity Land and building

Debt coverage formula (mortgage underwriters method) DCR = NOI/RM

RO = M x RM x DCR DCR = NOI/ADS

Chapter 22 3

Student Handbook to THE APPRAISAL OF REAL ESTATEChapter 22 4

Band of Investment—Mortgage and Equity

M (Mortgage ratio) x RM Weighted Amount

(1 – M) x RE + Weighted Amount

RO

The mortgageconstantRM can be calculatedby dividingthe annualdebtservices (ADS) by the initial amountof the mortgage. It can also becalculated on the financial calculator as follows:

N = 25 x 12

I/YR = 10/12

PV = -1

FV = 0

Solve for PMT 0.009087RM = PMT x 12 0.10904

0.75 x 0.10904 =

0.08178

0.25 x 0.13000 =

0.03250

0.11428

Student Handbook to THE APPRAISAL OF REAL ESTATEChapter 22 5

Band of Investment—Land and Building

L x RL = Weighted Amount

B x RB = + Weighted Amount

RO

0.75 x 0.1300 = 0.09750

0.25 x 0.0900 = + 0.0225

0.120 or 12.00%

Student Handbook to THE APPRAISAL OF REAL ESTATEChapter 22 6

Debt Coverage Formula

RO = M x RM x DCR

RO = 0.75 x 0.10797 x 1.2

RO = 0.09717

100,000 /0.09717 = $1,029,124

Student Handbook to THE APPRAISAL OF REAL ESTATEChapter 22 7

Residual Techniques

The subject has NOI of $45,000/year. The VL is $95,000.

95,000 (VL) x 0.09 (RL) = $8,550 (IL)

$45,000 (NOI) – 8,550 (IL) = 36,450 (IB)

$36,450 (IB) / 0.12 (RB) = $303,750

$303,750 + 95,000 = $398,750

The RL is 9% and the RB is 12%. What is the property value?

Student Handbook to THE APPRAISAL OF REAL ESTATEChapter 22 8

Gross Income Multipliers and Gross Rent Multipliers

Conditions Buyers think this way Similar expense ratios Similar upside potential

Student Handbook to THE APPRAISAL OF REAL ESTATEChapter 22 9

Sale and Rent Comparable Worksheet

Sale price Gross rent estimate GRM

1 $280,000 $2,500 112.00

2 320,000 2,900 110.34

3 305,000 2,750 110.91

4 275,000 2,500 110.00

5 330,000 2,900 113.79

6 325,000 2,900 112.07

7 300,000 2,700 111.11

8 298,000 2,700 110.37

9 285,000 2,500 114.00

10 290,000 2,750 105.45

Average 300,800 2,710 111.01

Student Handbook to THE APPRAISAL OF REAL ESTATEChapter 22 10

Problems

Suggested solutions begin on page 430.

Student Handbook to THE APPRAISAL OF REAL ESTATEChapter 22 11

Problems 1 and 3—Suggested Solutions

Problem 1Sale 1 Sale 2 Sale 3 Sale 4

Sale Price 1,000,000 750,000 650,000 500,000 NOI 98,000 75,000 62,500 49,500 IM 9.80% 10.00% 9.62% 9.90%

75,000 / 0.0975 = 769,231$ 75,000 / 0.1000 = 750,000$

PGI 100,000V & C -7,000EGI 93,000

Fixed -35,000Variable -25,000

Net income $33,000

33,000 /0.12 = 275,000

Problem 3

Student Handbook to THE APPRAISAL OF REAL ESTATEChapter 22 12

Problems 5 and 6—Suggested Solutions

QuickTime™ and aTIFF (LZW) decompressor

are needed to see this picture.

QuickTime™ and aTIFF (LZW) decompressor

are needed to see this picture.

Student Handbook to THE APPRAISAL OF REAL ESTATEChapter 22 13

Problems 7, 8, and 9—Suggested Solutions

Student Handbook to THE APPRAISAL OF REAL ESTATEChapter 22 14

Problem 10—Suggested Solution

Sale 1

Sale 2

Sale 3

Sale 4

PGI = 23,040 EGI = 21,888 NOI = 14,488 RO = 0.0827

PGI = 20,280 EGI = 19,266 NOI = 12,516 RO = 0.0834

PGI = 19,980 EGI = 18,981 NOI = 12,381 RO = 0.0853

PGI = 19,800 EGI = 18,810 NOI = 12,360 RO = 0.0797

Student Handbook to THE APPRAISAL OF REAL ESTATEChapter 22 15

Problem 10—Suggested Solution

$485$500$450$435

$1,855$22,260

Vacancy and collection loss 6.00% -$1,336$20,924

$2,800$2,200$2,200

$-$7,200 -$7,200

$13,724Capitalized value $13,724 / 0.08 = $171,555

Expenses

Monthly estimated rentAnnual potential gross income

Effective gross income

Unit 1Unit 2Unit 3

Reserves for replacement

Net operating Income

Taxes InsuranceVariable expenses

Unit 4

Estimated PGI