1 CHAPTER 13 VALUATION MODELS IN THE INCOME

2 DCF: Expected Cash Flows (NOIs) from Operations Copyright © 2001 by The Mc.

3 DCF: Expected Net Proceeds from Sale Copyright © 2001 by The Mc. Graw-Hill

4 Present Value of Expected Cash Flows (before debt) Copyright © 2001 by The

5 DCF using Expected Before -Tax Cash Flows • Assume the following loan terms

6 DCF: Expected BTCFs from Operations Copyright © 2001 by The Mc. Graw-Hill Companies,

7 DCF: Expected BTER from Sale Copyright © 2001 by The Mc. Graw-Hill Companies,

8 Present Value of Expected Cash Flows (BTCFs) Copyright © 2001 by The Mc.

9 DIRECT CAPITALIZATION • The Income Capitalization Equation is: V = I / R,

10 The Reconstructed Operating Statement • Potential Gross Income • Vacancy and Collection Losses

11 The Reconstructed Operating Statement Copyright © 2001 by The Mc. Graw-Hill Companies, Inc.

12 Direct Capitalization Estimate • The Income Capitalization Equation is: V = I /

13 Capitalization Rates and Yield Rates • The overall capitalization rate can be explained

14 Capitalization Rates Copyright © 2001 by The Mc. Graw-Hill Companies, Inc. All rights

15 Direct Market Extraction of RO Copyright © 2001 by The Mc. Graw-Hill Companies,

16 Simple Mortgage-Equity Analysis RO = [m. Rm + (1 -m)Re], where RO =

17 Mortgage-Equity Analysis Example Copyright © 2001 by The Mc. Graw-Hill Companies, Inc. All

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1 CHAPTER 13 VALUATION MODELS IN THE INCOME APPROACH • Discounted Cash Flow Analysis – value estimated as: the present value of the expected cash flows • Investment value uses the expected cash flows and discount rate of a particular investor. • Market value uses the expected cash flows and discount rate of the typical market participant. • Direct Capitalization – value estimated as: V = NOI / R Copyright © 2001 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

5 DCF using Expected Before -Tax Cash Flows • Assume the following loan terms available to a particular investor: – loan-to-value ratio = 80%, • thus, loan amount = $944, 000 x 0. 80 = $755, 200 – interest rate is 9. 5%, amortized over 30 years, paid monthly • thus, annual debt service = $6, 350 x 12 = $76, 202 • Assume the return required of the investor is 18 percent Copyright © 2001 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

9 DIRECT CAPITALIZATION • The Income Capitalization Equation is: V = I / R, where V = value, I = income, and R = capitalization rate. • Often used to estimate R, when V and I are known. R=I/V Copyright © 2001 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

10 The Reconstructed Operating Statement • Potential Gross Income • Vacancy and Collection Losses • Expenses – fixed – variable – reserves and other nonrecurring expenses – expense exclusions • Net Operating Income Copyright © 2001 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

12 Direct Capitalization Estimate • The Income Capitalization Equation is: V = I / R, where V = value, I = income, and R = capitalization rate. • Assume capitalization rate is estimated to be 9. 2% – Indicated value using the direct income capitalization approach: V = $ 86, 600 /. 092 = $ 934, 783 rounded to $ 934, 800 Copyright © 2001 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

13 Capitalization Rates and Yield Rates • The overall capitalization rate can be explained as: RO = y. O - g, where RO = the overall capitalization rate y. O = the discount rate (or yield rate), and g = the expected annual compounded rate of growth. Copyright © 2001 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

16 Simple Mortgage-Equity Analysis RO = [m. Rm + (1 -m)Re], where RO = the overall capitalization rate, m = loan-to-loan ratio, Rm = mortgage capitalization rate, and Re = equity capitalization rate. Copyright © 2001 by The Mc. Graw-Hill Companies, Inc. All rights reserved.