Valuation and the Appraisal Process of Real Estate

Income Capitalization

• Under income approach, the value of real estate is the present value of all future cash inflows

• The market value of property equals net operating income (NOI) divided by an appropriate market capitalization rate (R), V = NOI/R

• NOI (Net Operating Income) = potential gross income – vacancy and collection losses – operating expenses

• R (Market capitalization rate) is the percentage rate by which the future income stream is divided to arrive at a single figure that represents present value.

The concept of net operating income

• NOI is defined as the balance of cash remaining after deducting the operating expenses of a property from the gross income generated by the property. In determination of NOI, debt service on any existing or projected mortgages is ignored. Historic accounting depreciation deductions are ignored.

• Gross Rental receipts reflects the appraiser’s estimate of what rental income would be if the property were 100% occupied for 12-month period. In deriving GRR, the appraiser relies on three major sources: (1) records of the subject property (2) comparables, and (3) trends in the market place.

• After getting GRR, analyst must ascertain any additional income earned from sources other than rent. Examples are (1) automatic washers and dryers in the laundry room, (2) vending machines, (3) parking fees, (4) swimming pools, and (5) other amenity fees. GRR + other income represent potential gross income

• Effective gross income is derived by subtracting vacancy and collection loss from PGI. The vacancy and collection loss is calculated as a % of GRR (range between 5-15% of GRR). It reflects the experience of the subject property or of comparable properties in the area and also projected trend in the market.

• Operating expenses are directly related to the operation and maintenance of the property. Typical operating expenses include the following items: real estate taxes, payroll, maintenance and repair, fire and...