Real Estate Valuation

Market Value

• This is the estimated price a property would sell for on the open market.
• It is based on its highest and best use.

Transaction Price

• The actual price at which a property is sold.

Highest and Best Use

• The use of a property that maximizes its value.
• Is subject to zoning laws, market conditions, and physical characteristics.

Reconciliation

• This is the process of weighing and combining different valuation approaches.
• Approaches include sales comparison, cost, and income.
• Used to arrive at a final estimate of value.

Sales Comparison Approach

• A property valuation method based on the sale prices of similar, comparable properties in the same market.

Comparable Property

• A property similar to the one being appraised.
• Used in the sales comparison approach.

Arms-Length Transaction

• A transaction between two unrelated parties.
• Neither is under duress or compulsion.

Adjustments

• Changes made to the sale price of comparable properties.
• They account for differences in characteristics between the comparable and the subject property.

Cost Approach

• A valuation method based on the cost to replace or reproduce the property.
• Adjusted for depreciation and land value.

Reproduction Cost

• The cost to build an exact replica of the subject property.
• Uses the same materials and construction methods.

Replacement Cost

• The cost to build a similar property using modern materials and construction methods.

Accrued Depreciation

• The loss in value of a property due to physical deterioration, functional obsolescence, or external obsolescence.

Physical Deterioration

• Depreciation caused by wear and tear on the property over time.

Functional Obsolescence

• Depreciation caused by outdated design or features that make the property less desirable.

External (Economic) Obsolescence

• Depreciation caused by factors outside the property itself.
• Examples include changes in the neighborhood or market conditions.

Land Value

• The value of the land on which a property sits.
• Independent of the structures built on it.

Income Approach

• A valuation method based on the income a property generates.
• It is used for income-producing properties like rental or commercial real estate.

Direct Capitalization

• A method of valuing income-producing properties.
• Divides the annual net operating income (NOI) by the capitalization rate (Cap Rate).

Discounted Cash Flows (DCF)

• A method of valuation that estimates the value of a property.
• Calculates the present value of future cash flows.
• Considers both operating income and the reversion value at sale.

Net Operating Income (NOI)

• The total income generated by a property.
• Is after operating expenses, but before financing costs and taxes.

Effective Gross Income Multiplier (EGIM)

• A metric used to value a property based on its gross income.
• Calculated as the property price divided by the effective gross income (EGI).

NOI Calculation Terms

• NOI = Gross Income - Operating Expenses

Gross Income

• Total income from the property, including rent and other sources.

Operating Expenses

• Costs associated with running and maintaining the property.
• Excluding financing and tax expenses.

Cap Rate

• The rate of return on a property based on its income and value.
• Defined as the NOI divided by the property value.
• A lower cap rate indicates a higher property value relative to income, and vice versa.

Required Equity Investment

• The amount of money an investor must contribute in cash to purchase a property.
• Usually the down payment.

Debt Service

• The total annual amount required to pay off a loan.
• Includes both interest and principal.

Before-Tax Cash Flow (BTCF)

• The cash flow generated by a property after operating expenses and debt service, but before taxes.

Equity Dividend Rate

• Also called Cash-on-Cash Return.
• The ratio of annual before-tax cash flow (BTCF) to the initial equity investment.
• Expressed as a percentage.

Net Income Multiplier

• A valuation metric that is the inverse of the cap rate.
• Used to compare a property's price to its annual net income.

Effective Gross Income Multiplier

• A similar metric to the Net Income Multiplier, but based on gross income.

Operating Expense Ratio

• A ratio that compares a property's operating expenses to its gross income.

Loan-to-Value Ratio (LTV)

• A ratio that compares the amount of debt used to purchase a property to its appraised value.
• LTV = Loan Amount / Property Value

Debt Coverage Ratio (DCR)

• A ratio that measures a property's ability to cover its debt service with its net operating income.
• DCR = NOI / Debt Service

Debt Yield Ratio

• A ratio used by lenders to evaluate the return on the loan based on the property's NOI.
• Debt Yield = NOI / Loan Amount

CAPX Treatment

• Capital Expenditures (CAPX) are typically not included in NOI.
• They are one-time or long-term expenses.
• NOI reflects ongoing operational expenses.

Investor Borrowing

• Investors borrow to leverage their investment.
• Debt increases potential returns, as they only need to invest a portion of the total value.

BTCF vs NOI

• BTCF is after debt service and taxes.
• NOI is before debt service and taxes.

Ratios

• Measure various aspects of a property's financial health and performance.

Investment Valuation

• Based on the income-producing ability of a property (income approach).

Market Valuation

• Considers comparable sales (sales comparison approach) or cost (cost approach).

Leverage

• Using debt to finance an investment.
• Increases potential returns but also increases risk.

Levered Cash Flows

• Include debt payments.

Unlevered Cash Flows

• Are before debt payments and reflect the total income of the property.

Net Sales Proceeds

• The amount an investor receives from selling a property.
• After accounting for selling costs (e.g., agent fees, transaction costs).

Net Present Value (NPV)

• The present value of future cash flows, discounted at a required rate of return, minus the initial investment.

Reversion

• The sale of a property at the end of the investment period.
• Often calculated as the future value based on NOI and cap rate.

Internal Rate of Return (IRR)

• The discount rate that makes the NPV of all cash flows equal to zero.
• Represents the investment's effective annual return.

Key Course Learnings

• Ownership of real estate includes a bundle of rights, such as to sell, lease, or develop the property.
• Location significantly influences real estate value.
• Three valuation methods: Sales Comparison, Cost, and Income Approach (NOI).