Income Property Valuation

by Fisher, Jeffrey D.; Martin, Robert S.

• ISBN13: 9780884629801
• ISBN10: 0884629805
• Format: Hardcover
• Copyright: 1994-01-01
• Publisher: Dearborn Trade Pub

Summary

Ideal for a two and four year college course, this text provides comprehensive coverage of the appraisal of real estate income property.

Table of Contents

Preface	xix
About the Authors	xxiii
Introduction to Income Property Valuation	1	(18)
Income Property Investments	1	(1)
Components of Property Value	2	(2)
Nonrealty Interests	4	(2)
Personal Property	4	(1)
Business Value	5	(1)
Tax Incentives	5	(1)
Mortgage and Equity Interests	6	(1)
Real Estate Market Characteristics	6	(2)
No Organized Market	6	(1)
Availability of Market Information	7	(1)
Infrequent Trades of Property	7	(1)
Immobility of Real Estate	7	(1)
Each Parcel Is Unique	8	(1)
Segmented Markets	8	(1)
Government Regulations	8	(1)
Market Trends	9	(1)
Supply Adjusts Slowly	9	(1)
Few Buyers and Sellers at One Time	10	(1)
The Role of Capital Markets	10	(1)
Types of Real Estate Studies	11	(4)
Market Study	12	(1)
Marketability Study	12	(1)
Investment Analysis	12	(1)
Feasibility Study	12	(1)
Highest and Best Use Analysis	13	(1)
Environmental Impact Study	13	(1)
Cost-Benefit Study	14	(1)
Land Utilization Study	14	(1)
Appraisal	14	(1)
Need for an Appraisal Process	15	(1)
Summary	15	(1)
Key Terms	16	(1)
Questions	17	(1)
End Note	17	(2)
Appraisal Principles and Highest and Best Use Analysis	19	(24)
Appraisal Principles	19	(3)
Anticipation	19	(1)
Change	19	(1)
Supply and Demand	20	(1)
Substitution	20	(1)
Balance	21	(1)
Conformity	21	(1)
Contribution	21	(1)
Opportunity Cost	21	(1)
Utility	21	(1)
The Function of Real Estate Appraisals	22	(2)
Financing	22	(1)
Determining a Listing Price	22	(1)
Supporting a Sales Price	22	(1)
Property Taxation	23	(1)
Condemnation Appraisal	23	(1)
Lease versus Buy Decisions	23	(1)
New Project Feasibility	23	(1)
Litigation of Property Rights and Interests	23	(1)
Project Performance	24	(1)
Fire and Causalty Insurance	24	(1)
Types of Value	24	(3)
Market Value	24	(1)
Market Price	25	(1)
Cost	25	(1)
Investment Value	25	(1)
Value in Use	25	(1)
Assessed Value	26	(1)
Insurable Value	26	(1)
Going-Concern Value	26	(1)
Salvage Value	26	(1)
Book Value	26	(1)
Mortgage Loan Value	27	(1)
Liquidation Value	27	(1)
Market Value versus Investment Value and Value in Use	27	(1)
The Appraisal Process and Highest and Best Use Analysis	28	(9)
Identification of the Appraisal Problem	28	(2)
Assumptions, Limiting Conditions and Certification	30	(1)
Collection and Analysis of Market Data	31	(1)
Tests of Highest and Best Use	32	(2)
The Three Approaches to Value	34	(2)
Valuation Conclusion	36	(1)
Value Component Appraised	37	(2)
Value of a Fee Simple Interest	38	(1)
Value of Leased Fee and Leasehold Interests	38	(1)
Nonrealty Interests	39	(1)
Summary	39	(1)
Key Terms	40	(1)
Questions	41	(1)
End Notes	42	(1)
Market Area and Neighborhood Analysis	43	(36)
Function of Market Analysis	43	(1)
The Market Analysis Process	44	(4)
Identification of the Area To Be Analyzed	44	(2)
Data-Gathering Techniques	46	(2)
Market Analysis	48	(8)
Physical (Environmental) Factors	49	(1)
Economic Trends	50	(3)
Government Regulations	53	(2)
Social Factors	55	(1)
Conclusions	55	(1)
Summary	56	(1)
Key Terms	57	(1)
Questions	57	(1)
Typical Market Study---Retail	58	(7)
Typical Market Study---Residential	65	(6)
Typical Market Study---Office	71	(8)
Compound Interest and Discount Factors	79	(30)
Importance of the Time Value of Money	79	(1)
Variables in the Discounting Process	80	(1)
Interest Rate	80	(1)
Present Value	81	(1)
Compound Interest and Discount Factors	81	(8)
Future Value of One Dollar	81	(1)
Future Value of One Dollar per Period	82	(2)
Sinking Fund Factor	84	(1)
Present Value of One Dollar	85	(1)
Present Value of One Dollar per Period	86	(2)
Payment To Amortize One Dollar	88	(1)
Mortgage Capitalization Rate	89	(2)
Monthly Payments	90	(1)
Effective Annual Rate	90	(1)
Interrelationship Among the Factors	91	(1)
Present Value Applications	91	(11)
Present Value of a Level Income Stream	91	(1)
Present Value of a Level Income Stream Plus a Reversion	92	(1)
Present Value of Variable Income	93	(1)
Present Value of Cash Flows Received in Advance	94	(1)
Interest Rate Calculation	95	(2)
The Internal Rate of Return	97	(1)
Internal Rate of Return Issues	98	(4)
Mortgage Loan Calculations	102	(3)
Calculating Loan Payments---Level Amortizing Mortgages	103	(1)
Calculating a Loan Balance---Level Amortizing Mortgages	104	(1)
Summary	105	(1)
Key Terms	105	(1)
Questions	106	(1)
End Notes	106	(3)
Cash-Flow Forecasting	109	(20)
Real Estate Cash-Flow Forecasts	109	(1)
Forecasting	109	(1)
Types of Income	110	(1)
Cash-Flow Forecasts from Operations	111	(2)
Sources of Annual Income	111	(1)
Operating Expenses	112	(1)
Net Operating Income	113	(1)
Resale Proceeds Forecast	113	(2)
Holding Period	113	(1)
Resale Value	114	(1)
Disposition Costs	115	(1)
Cash-Flow Forecasts	115	(2)
Rental Income Calculations	115	(1)
Vacancy and Credit Loss Estimate	116	(1)
Effective Gross Income	117	(1)
Operating Expenses	117	(2)
Replacement Reserves	119	(1)
Cash-Flow Example	120	(1)
Estimating Resale Proceeds	121	(3)
Direct Dollar Forecast	121	(1)
Estimated Percent Change	121	(1)
The Terminal Capitalization Rate	122	(2)
Sources of Income and Expense Data	124	(1)
Summary	125	(1)
Key Terms	125	(1)
Questions	126	(1)
End Notes	126	(3)
Investment Return Calculations	129	(14)
Introduction	129	(1)
Investor Motivations	130	(1)
Preservation of Capital	130	(1)
Earning Investment Profit	131	(1)
Real Estate Return Measures	131	(2)
Calculation of Investment Return Measures	133	(7)
Payback Period	133	(1)
Income Multipliers	134	(1)
Overall Capitalization Rate	134	(2)
Land and Building Capitalization Rates	136	(1)
Property Yield Rate	137	(1)
Net Present Value	138	(1)
Profitability Index	139	(1)
Adjusted Internal Rate of Return	139	(1)
Summary	140	(1)
Key Terms	141	(1)
Questions	141	(1)
End Notes	142	(1)
Income Capitalization Approach	143	(40)
Income Approach in the Valuation Process	143	(1)
Income Capitalization Methods	144	(2)
Direct Capitalization	144	(1)
Yield Capitalization	145	(1)
Application of the Income Approach	146	(3)
Office Buildings	146	(1)
Retail Shopping Centers	147	(1)
Multifamily Residential Properties	147	(1)
Industrial Properties	147	(1)
Hotels and Motels	148	(1)
Development Projects	148	(1)
Special-Use Properties	148	(1)
Estimating Value Using First-Year Cash-Flow Factors and Rates of Return	149	(5)
Direct Capitalization Using PGIM, EGIM and NIM	150	(1)
Direct Capitalization Using on Overall Rate	151	(1)
Residual Techniques Using Direct Capitalization	152	(2)
Yield Capitalization (Discounted Cash-Flow Analysis)	154	(6)
Estimating Value Using Yield Capitalization Formulas	160	(10)
Stabilizing Income	170	(8)
Income Stabilization Factor	171	(1)
Adjusting the Capitalization Rate	172	(1)
K Factor	173	(1)
J Factor	174	(4)
Summary	178	(1)
Key Terms	179	(1)
Questions	180	(1)
End Notes	181	(2)
Sales Comparison Approach	183	(14)
Introduction	183	(1)
Sources of Comparable Data	184	(1)
Identification of Units of Comparison	184	(1)
Elements of Comparison	185	(3)
Ownership Interest	186	(1)
Cash Equivalency	187	(1)
Conditions of Sale	187	(1)
Market Conditions	187	(1)
Locational Attributes	187	(1)
Physical Characteristics	188	(1)
The Adjustment Process	188	(1)
Sales Comparison Approach Example	189	(5)
Summary	194	(1)
Key Terms	195	(1)
Questions	195	(1)
End Notes	196	(1)
Site and Improvements Description and Analysis	197	(16)
Site Description	197	(3)
Physical Features	197	(2)
Locational Attributes	199	(1)
Government and Legal Restrictions	200	(2)
Zoning	200	(1)
Building Permits and Inspections	200	(1)
Legal Restrictions	201	(1)
Taxation	201	(1)
Economic Issues	202	(1)
Plottage	202	(1)
Excess Land	202	(1)
Site Analysis	203	(1)
Improvements Description	204	(6)
General Characteristics	204	(1)
Construction Components	205	(3)
Functional Utility	208	(1)
Physical Depreciation	208	(1)
Functional Depreciation	209	(1)
External Depreciation	209	(1)
Economic Life	210	(1)
Summary	210	(1)
Key Terms	211	(1)
Questions	211	(2)
Site Valuation	213	(14)
Introduction	213	(1)
Approaches to Site Valuation	213	(10)
Sales Comparison Approach	214	(3)
Extraction Method	217	(1)
Development Approach	217	(5)
Capitalization of Ground Rent	222	(1)
Allocation	222	(1)
Land Residual	223	(1)
Excess Land	223	(1)
Summary	223	(1)
Key Terms	224	(1)
Questions	224	(3)
The Cost Approach	227	(18)
Introduction	227	(1)
Cost New	228	(6)
Type of Costs	229	(1)
Methods of Estimating Costs	230	(3)
Sources of Cost Information	233	(1)
Depreciation	234	(9)
The Age-Life Approach	235	(1)
The Breakdown Method	235	(7)
The Market Extraction Method	242	(1)
Summary	243	(1)
Key Terms	243	(1)
Questions	244	(1)
End Notes	244	(1)
Leased Fee and Leasehold Valuation	245	(20)
Introduction	245	(1)
Cash-Flow Forecasting with Existing Leases	246	(1)
The Lease Agreement	247	(3)
Data of Agreement and Parties to the Lease	248	(1)
Description of the Leased Premises and Uses Allowed for the Property	248	(1)
Commencement Date and Length of Time of the Lease	248	(1)
Payment Amount or Method of Calculation of Rent	248	(1)
Responsibility for Expenses	249	(1)
Remaining Lease Provisions	250	(1)
Net Operating Income Forecasts	250	(1)
Resale Proceeds Forecast	251	(3)
Leased Fee Discount (Yield) Rate	254	(1)
Leased Fee Cash-Flow Forecast---A Case Study	254	(2)
Fee Simple Value Estimate	256	(1)
Leased Fee Value Estimate	257	(1)
Market Rent Equivalency Adjustment	258	(1)
Leasehold Value Estimate	259	(1)
Supporting Leasehold Discount Rates	260	(1)
Summary	261	(1)
Key Terms	262	(1)
Questions	262	(1)
End Notes	263	(2)
Investment Measures with Mortgage Financing	265	(22)
Impact of Financing on Real Estate Cash-Flow Forecasts	265	(1)
Calculation of Investment Returns, Assuming Financing	266	(5)
Payback Period	267	(1)
Equity Capitalization Rate	267	(1)
Before-Tax Equity Yield Rate	268	(1)
Net Present Value	269	(1)
Profitability Index	270	(1)
Adjusted Internal Rate of Return	271	(1)
Financial Leverage	271	(12)
Cash-Flow Leverage	273	(1)
Effect of Leverage on Equity Dividend Rate	273	(1)
Effect of Leverage on Equity Yield Rate	274	(1)
Summary of Leverage Relationships	275	(1)
Leverage and Market Value	276	(1)
Loan Amount Determination	277	(1)
Loan Types	278	(5)
Other Types of Financing	283	(1)
Summary	283	(1)
Key Terms	284	(1)
Questions	284	(1)
End Notes	285	(2)
Valuation of Mortgage and Equity Interests	287	(22)
Introduction	287	(1)
Estimating Value Using First-Year Capitalization Rates	288	(3)
RE and a Loan-to-Value Ratio (Band of Investment)	288	(2)
RE and a Fixed Loan Amount (Equity Residual Technique)	290	(1)
Underwriter's Method	290	(1)
Estimating Value Using Discounted Cash-Flow Analysis	291	(6)
Variable BTCF and Fixed Resale Price	292	(1)
Level BTCF and Resale Using Terminal Capitalization Rate	293	(1)
Level Income, Fixed Resale and Debt Coverage Ratio	294	(1)
Level Income, Unknown Sales Price and Loan-to-Value Ratio	295	(2)
Estimating Value Using Yield Capitalization	297	(4)
Basic Mortgage/Equity Discounted Cash-Flow Relationship	298	(1)
Value Solution Assuming Level Income, Percent Change in Value and Loan-to-Value Ratio	298	(3)
Stabilizing Income with the Ellwood Formula	301	(5)
Ellwood Equation with a Debt Service Coverage Ratio	304	(2)
Summary	306	(1)
Key Terms	306	(1)
Questions	307	(1)
End Notes	307	(2)
Valuation of Nontypical Mortgage Financing	309	(16)
Introduction	309	(1)
Mortgage Loan Review	310	(1)
Payment and Ending Balance Reversion	311	(1)
Impact of Below-Market Financing	311	(2)
Below-Market Interest Rates	312	(1)
Longer Amortization Terms	312	(1)
Assumability of Loan at Resale	312	(1)
Higher Loan-to-Value Ratio	313	(1)
Estimating the Impact of Beneficial Financing	313	(6)
Interpretation of Cash Equivalency	315	(1)
More Realistic Assumptions	315	(2)
Cash Equivalency Based on Investor's Expectations	317	(1)
Alternative Solution	317	(1)
Conclusions About Cash Equivalency	318	(1)
Paired Sales Analysis	319	(1)
Mortgage Valuation	319	(2)
Valuation of Mortgages with Participations	319	(2)
Summary	321	(1)
Key Terms	321	(1)
Questions	322	(1)
End Note	323	(2)
Risk Analysis	325	(14)
Introduction	325	(1)
Type of Risk	325	(3)
Space Market Risk	326	(1)
Capital Market Risk	326	(1)
Financial Risk	326	(1)
Liquidity Risk	326	(1)
Inflation Risk	327	(1)
Environmental Risk	327	(1)
Legislative Risk	327	(1)
Management Risk	328	(1)
Sensitivity Analysis	328	(1)
Expected Return	328	(1)
Variance and Standard Deviation	329	(1)
Ranking Investments	329	(1)
Expected Present Value	330	(1)
Partitioning the IRR	331	(1)
Discounting NOI and Reversion at Different Rates	332	(1)
Effect of Leverage on Financial Risk	333	(1)
Summary	334	(1)
Key Terms	335	(1)
Questions	335	(2)
End Note	337	(2)
Tax Considerations in Income Property Valuation	339	(16)
Introduction	339	(1)
Taxable Income from Operation of Real Estate	340	(1)
Depreciation Allowances	340	(1)
Depreciation of Personal Property	340	(1)
Loan Points	341	(1)
Taxable Income from Sale of Depreciable Real Property	341	(1)
After-Tax Investment Analysis	342	(4)
After-Tax Cash Flow from Operation	342	(2)
Depreciation	344	(1)
After-Tax Cash Flow from Sale	344	(1)
After-Tax IRR	345	(1)
Classification of Income	346	(2)
Special Exceptions: Loss Allowances for Rental Real Estate	347	(1)
Valuation Using an After-Tax Approach (Optional)	348	(4)
Conclusion	351	(1)
Summary	352	(1)
Key Terms	352	(1)
Questions	352	(1)
End Notes	353	(2)
Selecting and Supporting the Discount Rate	355	(26)
Introduction	355	(1)
Discount Rate Examples	356	(1)
Property Yield (Discount) Rate: YO	357	(1)
Before-Tax Equity Yield (Discount) Rate: YE	357	(1)
Selection of Rates	357	(10)
Buildup Method	357	(1)
Alternative Investment Comparison	358	(1)
Discount Rate Extraction from Comparables	359	(2)
Graphical Analysis	361	(6)
Yield for Alternative Investments	367	(1)
Real versus Nominal Discount Rates	368	(2)
Relationship Between Real and Nominal Rates	368	(2)
Review of Relationships Among Rates	370	(2)
Expected Relationship Between YO (Fee Simple) and YLF (Leased Fee)	370	(1)
Expected Relationship Between YO and RO	370	(1)
Expected Relationship Between YE and RE	371	(1)
Expected Relationship Between RO and RE	371	(1)
Expected Relationship Between RO (Going-In Cap Rate) and RN (Terminal Cap Rate)	371	(1)
Expected Relationships Between YO, YE and YM	372	(1)
Expected Relationship Between YE (Pretax) and YE (After Tax)	372	(1)
Summary	372	(1)
Key Terms	373	(1)
Questions	373	(1)
End Notes	374	(1)
Appendix: Graphic Analysis with Ellwood Equation	375	(6)
Highest and Best Use Analysis: Applications	381	(20)
Introduction	381	(1)
Importance of Highest and Best Use	382	(1)
The Four Tests of Highest and Best Use	382	(3)
Physically Possible	383	(1)
Legally Permitted	383	(1)
Financially Feasible	384	(1)
Maximally Productive	384	(1)
Highest and Best Use of the Land	385	(1)
Highest and Best Use of Improved Property	385	(1)
Highest and Best Use Examples	386	(11)
Highest and Best Use of Vacant Land	386	(4)
Land Density Issue	390	(3)
Underimprovement	393	(1)
Highest and Best Interim Use	394	(1)
Conversion	395	(2)
Summary	397	(1)
Key Terms	398	(1)
Questions	398	(3)
Valuation of Proposed Projects	401	(16)
Introduction	401	(1)
Value ``As Is''	401	(1)
Prospective Value on Completion but Prior to Rentup	401	(1)
Prospective Value on Reaching Stabilized Occupancy	402	(1)
Value ``As Is''	402	(1)
Prospective Value on Completion but Prior to Rentup	403	(7)
Income Approach	404	(4)
Cost Approach	408	(1)
Sales Comparison Approach	409	(1)
Prospective Value on Reaching Stabilized Occupancy	410	(5)
Income Approach	411	(2)
Cost Approach	413	(1)
Sales Comparison Approach	414	(1)
Summary	415	(1)
Key Terms	416	(1)
Questions	416	(1)
Valuation of Distressed Properties	417	(16)
Introduction	417	(1)
External Obsolescence	417	(1)
Economic Obsolescence	418	(1)
Locational Obsolescence	418	(1)
Occupancy Obsolescence	418	(1)
Functional Obsolescence	418	(1)
Property Inspection and Analysis	419	(11)
Income Approach	419	(2)
Cost Approach	421	(1)
Sales Comparison Approach	421	(9)
Summary	430	(1)
Key Terms	431	(1)
Questions	431	(2)
Case Study: Appraisal of Bay Hill Apartments	433	(52)
Appendix A. Annual Compound Interest Tables	485	(28)
Appendix B. Monthly Compound Interest Tables	513	(28)
Appendix C. Online Resources	541	(16)
Glossary of Terms and Symbols	557	(28)
Index	585