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CHAPTER TERMS AND CONCEPTS
Amenities
Capital recovery
Capitalization
Capitalization rate
Contract rent
CPI lease
Direct capitalization
Effective gross income
Excess rent
Fixed expenses
Gross income
Gross income multiplier (GIM)
2
Income property
Intangible benefit
Lease term
Market rent
Minimum or base rent
Net income ratio
Net operating income
Operating expense ratio
Operating expenses
Operating statement
Overage rent
Percentage lease
CHAPTER TERMS AND CONCEPTS
Potential gross income
Present worth of future benefits
Recapture
Rent roll
Reserves for replacements
Return of investment
Return on investment
Step-up (or “graduated”) lease
Straight (or “flat”) lease
Tangible benefit
Variable expenses
3
LEARNING OUTCOMES
1. Distinguish between the tangible and intangible benefits of property ownership.
2. Name the six steps in the income approach to value.
3. Explain the use of gross income multipliers in the income approach.
4. Define the terms contract rent and market rent as used in appraisals.
5. Name the three main categories of expenses and give examples of items in each.
6. Outline the procedure used for reconstructing the owner’s operating statement.
4
Types of Income Property
1. Multiple-family residential, including large and small apartment buildings.
2. Commercial buildings, including stores, offices, medical offices, convalescent hospitals, hotel and motel properties, and shopping centers.
3. Industrial properties, such as warehouses and factories.
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MOTIVES AND BENEFITS OF PROPERTY OWNERSHIP
Intangible Benefits
Pride of ownership
Sense of security
Personal opportunity
Tangible Benefits
Return on investment
Return of investment
7
CHARLEY’S SAVING ACCOUNT
How Much is in Charley’s Savings Account?
Amount on Deposit?
$216
$600
$360
$6,000
We give 6%Hi Charley! Here’s your $36 annual check!
9
IRV FOR VALUE
The Value Formula
Key Horizontal line indicates division Vertical line indicates multiplication
Formulas Value = I/R Rate = I/V Income = R X V
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BASIC STEPS: INCOME APPROACH
• Estimate the Annual Gross Income
• Estimate Vacancy and Other Losses
• Subtract to Get Effective Gross Income
• Subtract Operating Expenses to Get Net Operating Income
• Arrive at a “Cap” Rate and Method
• Divide Net Operating Income by Capitalization Rate
11
Analysis of GIM
Gross % Net Cap
Income Expenses Income Rate Price GIM
$30,000 40.00% $18,000 6% $300,000 10
$30,000 50.00% $15,000 6% $250,000 8.3
$30,000 60.00% $12,000 6% $200,000 6.7
Gross Income Multipliers
GIM = Price ÷ Gross Income
Price Gross Income GIM
$300,000 $30,000 10.0
$250,000 $30,000 8.3
$200,000 $30,000 6.7
Effect of Expense Ratios
12
Analysis of GIM
GIM Varies with: Location Intangible Amenities Number of Units Expense Ratio Size of Units Services Included
13
MARKET RENT
Market Rent Defined Potential gross rent Assumes no encumbrances Assumes efficient management Measures all the property rights
o Overage Rento Excess Rent
Responsibility for Expenseso Landlordo Tenanto Shared
Contract Rent
• rent being paid under some form of contract that is binding on both owners and tenants. Such rental agreements range from simple oral contracts to complex leases that are beyond the scope of this book.
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Types of tenancieso Month to Montho Short-term Leaseo Long-term Lease
Common Lease Typeso Straighto Step Upo Percentage o Combinations
CONTRACT VS. MARKET RENT
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OPERATING EXPENSES
What to Include: Include Property-Related Expenseso Current Operating Expenseso Projected Expenditureso The Value of Owners Efforts
Exclude Owner-Related Expenses, such as:o Loan and Interest Paymentso Income Taxeso Depreciation
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OPERATING EXPENSES CATEGORIES
Operating Expense Categories Variable Expenses Fixed Expenses Reserves for Replacement
INCOME AND EXPENSE RATIOS
Income and Expense Ratios
The Net Income Ratio = NOI ÷ EGI
The Operating Expense Ratio = Operating Expenses ÷ EGIo NOI = Net Operating Incomeo EGI = Effective Gross Income
18
SUMMARY
21
An overview of the income approach as it applies to various types of residential income, commercial, and industrial properties was also included. The income approach can either analyze the income year-by-year, or by emphasizing one year. Income property appraisals require an estimate of income and expenses for the property. A knowledge of typical expense ratios assists in the reconstruction of operating expense statements.