Real Estate Value – What is Value?

REAL ESTATE VALUE – WHAT IS VALUE? SPECIAL SKILLS

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REAL ESTATE VALUE DEFINED Basic Definitions: • Real Estate Value = present worth of future benefits • Future Benefits = annual benefits + reversionary benefits • Reversionary Benefits = income from sale of property

So that real estate value can be further defined as: Real Estate Value = present worth of annual benefits + present worth of reversionary benefits

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TYPES OF REAL ESTATE VALUE • Market Value as defined by “Uniform Appraisal Standards for Federal Land Acquisitions” (also known as The Yellow Book): “Market value is the amount in cash, or terms reasonably equivalent to cash, for which in all probability the property would have sold on the effective date of the appraisal, after a reasonable exposure time on the open competitive market, from a willing and reasonably knowledgeable seller to a willing and reasonably knowledgeably buyer, with neither acting under any compulsion to buy or sell, giving due consideration to all available economic uses of the property at the time of the appraisal.” The Appraisal of Real Estate. Chicago, IL: Appraisal Institute, 2008. Page 25.

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TYPES OF REAL ESTATE VALUE • Investment Value as defined by The Appraisal Institute: “The specific value of a property to a particular investor or class of investors based on individual investment requirements; distinguished from market value, which is impersonal and detached.” The Appraisal of Real Estate. Chicago, IL: Appraisal Institute, 2008. Page 29.

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TYPES OF REAL ESTATE VALUE • Market Value

• Normative, objective, consensus, and carefully defined (sometimes called “fair” market value) • Appraisers usually estimate market values based on the behavior of typical buyers and sellers • Developer sells improved product to the “market” • Investment Value

• Individual, subjective, and strategic • Developers usually estimate investment value based on the unique terms of a specific deal • Developer buys the unimproved product at his/her “investment value” For Educational Use Only

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REAL ESTATE VALUE DEFINED Seller Investment Value ≤ Buyer Investment Value (seller sets the floor)

(buyer sets the ceiling)

• Seller Investment Value = least seller can accept for a property and still achieve her target objectives • Buyer Investment Value = most buyer can pay and still achieve her target objectives

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VALUE ESTIMATIONS Direct Capitalization Model

General Form: 𝐼𝑛𝑐𝑜𝑚𝑒 (𝐼) 𝑉𝑎𝑙𝑢𝑒 𝑉 = 𝐶𝑎𝑝𝑖𝑡𝑎𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛 𝑅𝑎𝑡𝑒 (𝑅) For Property Value: 𝑃𝑟𝑜𝑝𝑒𝑟𝑡𝑦 𝑉𝑎𝑙𝑢𝑒 𝑉0 =

Discounted Cash Flow Model

General Form:

𝑛

𝑉𝑎𝑙𝑢𝑒 𝑉 = 𝑡=1

𝐼𝑛𝑐𝑜𝑚𝑒𝑡 𝑅𝑒𝑣𝑒𝑟𝑠𝑖𝑜𝑛𝑛 + 1+𝑌 𝑡 (1 + 𝑌)𝑛

For Property Value:

𝑁𝑒𝑡 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐼𝑛𝑐𝑜𝑚𝑒 (𝐼0) 𝑂𝑣𝑒𝑟𝑎𝑙𝑙 𝐶𝑎𝑝𝑖𝑡𝑎𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛 𝑅𝑎𝑡𝑒 (𝑅0)

𝑛

𝑃𝑟𝑜𝑝𝑒𝑟𝑡𝑦 𝑉𝑎𝑙𝑢𝑒 𝑉0 =

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𝑡=1

𝑁𝑒𝑡 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐼𝑛𝑐𝑜𝑚𝑒0 𝑃𝑟𝑜𝑝𝑒𝑟𝑡𝑦 𝑅𝑒𝑣𝑒𝑟𝑠𝑖𝑜𝑛𝑛 + 1 + 𝑌0 𝑡 (1 + 𝑌0)𝑛

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DIRECT CAPITALIZATION MODEL IN DEVELOPMENT PROCESS 𝐼0 𝑉0 = 𝑅0

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REAL ESTATE VALUE ESTIMATED: DIRECT CAPITALIZATION MODEL 𝑉0 =

𝐼0 𝑅0

Overall Property Value (V0) = Net Operating Income (I0) ÷ Overall Capitalization Rate (R0) Net Operating Income (I0) = Gross Income (GI) – Vacancy (VC) – Operating Expenses (OE) There are many ways to define and calculate the Overall Capitalization Rate. In its simplest form the Overall Capitalization Rate is the ratio between Net Operating Income (I 0) and the Property Value (V0) The simplest derivation of the Overall Capitalization Rate (R0) is a risk-adjusted rate of discount (Y0) reduced by the expected future growth rate of the property is income and value (g) R0 = Y 0 - g

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REAL ESTATE VALUE ESTIMATED: A SIMPLE NUMERICAL EXAMPLE Assumptions Gross Income = $100,000 Vacancy and Collection = 10% of Gross Operating Expenses = 33% of Effective Gross Income Overall Cap Rate = 10% Gross Income (GI)

100,000

- Vacancy & Collections (VC)

(10,000)

Effective Gross Income (EGI)

90,000

- Operating Expenses (OE)

(30,000)

Net Operating Income (I0)

60,0000

÷ Overall Cap Rate (R0)

10%

Property Value (V0)

$600,000 For Educational Use Only

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