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Cost
Table of Contents
Chapter 1
Chapter 2
Chapter 3
Chapter 4
Chapter 5
Chapter 6
Chapter 7
Cost Concepts
Depreciation
Land Value
Cost Approach
Highest & Best Use
Market Analysis
Feasibility Analysis
1
7
15
23
31
39
49
Ted Whitmer, MAI
2508 Merrimac Ct.
College
g Station,, TX 77845
Phone: (979) 690-9465
Email: [email protected]
Website: www.tedwhitmer.com
NOTES
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Chapter 1
Cost Concepts
The cost approach is probably the least favored approach to value. However, the fundamental relationship between
the cost of a project and market value absolutely must be understood. The direction of a local real estate market can
be determined by the understanding of how the cost of putting improvements on the ground affects the value of real
estate.
One old investor remarked that it is not purchasing on low rates of return or yields that gets investors in trouble, but
buying properties over cost. In a market characterized by relatively low rental rates relative to market rental rates,
the rates must out-pace inflation if new product is to be built. This could be seen in the over-built markets of the
1980’s when rates declined by 50% or greater. The rates had to increase 100% to just get back to their previous
levels. The markets all experienced higher than inflation increases to get back to a healthy real estate market.
Market direction can be determined by comparing cost to value. If the cost to complete a property (with sufficient
profit) is less than value, then there is a “true” profit and money will be attracted to that type of property in that
location. Often land values for the particular use will spike until the true profit goes away or so much product will be
built that there is a downward pressure on profits and it goes away. If the cost to complete a property is greater than
value, then construction will cease. Since there is a lag between conception of a project and permitting, the building
may briefly continue once the market realizes it is over-built. Furthermore, some builders will build at no profit to
even a loss to prevent carrying land, with its associated costs, in a soft market.
The understanding of the underlying land value as compared to the contribution of the improvements also helps
assess risk of a project. One investor bought a retail center because the underlying land value created a safety net in
case the building didn’t perform. A Putt-Putt facility was purchased for essentially land value. This is the application
of the cost approach.
A developer once remarked that he likes to develop steel buildings because appraisers always overvalue them based
upon cost. In other words, the appraisers do not understand cost.
Finally, after attending a seminar an appraiser from the northeast wrote a letter expressing his disfavor with the cost
approach and stated he was on a REIT board that bought real estate. He stated that they did not consider cost, but in
the closing of his letter stated “of course we do not purchase for over the replacement cost of the improvements.”
How does he know?
The cost approach is probably in disfavor because the theory in textbooks is evolving and in many cases flawed.
Furthermore, many appraisers believe they have to break down the depreciation method. This is not a requirement
for employing proper methodology, as there are alternative methods to estimate depreciation.
Summation approach
¾
¾
Land value (from 1 or more of 6 acceptable methods), plus
Value of improvements
o Cost new as of the appraisal date (never when built)
o Minus: Depreciation (depreciation is an adjustment to cost to indicate value of improvements)
Copyright Ted Whitmer. All rights reserved.
Cost
1
Cost
Misconceptions
¾
The cost approach is most applicable to new buildings. In fact, it is applicable when sufficient data
concerning cost, depreciation and site value is available regardless of use. Additionally, it is often very
accurate at the end of the economic life of improvements because most of the total value is land value. If
land value can be supported, then the cost approach is a very good indicator of value.
ƒ
Example: Land value is $500,000. Improvements are 35 years old with a remaining
economic life of 5 years and would cost $1,000,000 to replace. Given economic age-life
the improvements have value of 5 years/ 40 (total economic life) or 12.5% of total cost
($125,000). Therefore, the land value comprises 80% of total value. Even if the value of
the improvements is over or understated by 50% ($62,500), this is only 10% of the total
value. Therefore, the cost approach is a reliable indication for an older building.
¾
The market does not consider the cost approach. In fact, many buyers purchase because it “would cost x%
more to build than to buy.”
¾
The cost approach is applicable to special purpose properties. No matter what the property, an experienced
appraiser would like sales of similar properties and would rather rely on a sales comparison approach than a
cost approach. Special purpose or use properties are often characterized by their uniqueness and/or lack of
sales of properties that are similar. Therefore, the cost approach is not so much applicable as it is necessary
without income and sales information. The result is generally less reliable than with more data.
Additionally, the appraisal is usually for “use value” which means we do not feel comfortable to call the
result “market value.”
Relation to appraisal principles
Substitution – people will not pay more for a property than the cost of another property built for the
specific design and demand of the person(s), without undue delay.
Supply & demand – If the market is characterized by shortage, cost with true or economic profit may
explain value. If the market is characterized by over-supply, cost with significant obsolescence may
explain value.
Balance – The agents of production are land, labor and capital and coordination or profit(profit is
sometimes included in labor). Value is maximized when the agents of production are in their proper
mix. Furthermore, the components of a cost approach are land (same as the first agent of production)
and direct, indirect costs and profit (same as labor and capital).
Externalities – Forces outside the property good and bad affect value and the cost approach. Good
locational attributes are expressed in high land value and bad may affect obsolescence.
Highest & best use – Cost can be used to help establish highest and best use. The highest and best use
of the land is the use that produces the highest value (not rate of return) to the land. This analysis can
be made after studying value versus cost and deriving residual land values by comparing the two. The
highest and best use as improved can also be studied with a cost approach related to deferred
maintenance or other curable or incurable items. The cost versus value added analysis aids in
determining if an item is curable (spend the money now to correct) or incurable (spend money later or
not at all). The cost approach is essential for the highest and best use as vacant or as improved to be
understood.
Copyright Ted Whitmer. All rights reserved.
Cost
2
Cost
Cost Approach
Reliability
À The cost approach is applicable when the
improvements are new & when the improvements are
older!
High
Reliability
Low
New
Old
Age of
Property
Copyright Ted Whitmer. All rights reserved.
Cost
3
Cost
Cost Approach
CostApproach
• ReproductionCost
Reproduction Cost
• ReplacementCost
Replacement Cost
– Exactcopy
– Cana5yearoldhouse
Can a 5 year old house
byreproduced?What
aboutHVAC?TheSER
haschangeddrastically
inthelast5to10
years You cannot
years.Youcannot
purchaseHVACunits
withlowSERs.
– Doesthisrelateto
marketvalue
definition?
– Sameutility
– Onlycostoffunctional
Only cost of functional
superadequateitemsare
differentthanfor
reproductioncost.
Therefore,itisamodified
Reproduction cost
Reproductioncost.
– Itdoesnotbuildthe
buildingthatisappraised
Profit in the Cost Approach
ProfitintheCostApproach
y Salepriceminuscost,excludingprofit?
y Isitwhatitwouldtaketobuildimprovementsasone
oftheagentsofproduction?
Ń Land
Ń Labor
Ń Capital
C it l
Ń Profitorcoordination
y Isitonlyintheimprovements?
y Whataboutchurches&ownerͲoccupiedbuildings?
p
g
Copyright Ted Whitmer. All rights reserved.
Cost
4
Cost
C tA
CostApproachConsiderations
h C id ti
yThefouragentsofproduction
areland,labor,capitaland
coordination.Thisappliestoany
goodsorservices.Thecost
d
i
Th
t
approachexpressesthefour
agents.Thevalueoftheland+
direct & indirect costs (labor &
direct&indirectcosts(labor&
capital)andprofit(coordination)
areelementsofcost.Profit,in
thecostapproach,isnotthe
diff
differencebetweencostand
b t
t d
value,butisacost,&should
alwaysbeincluded.
yNewertextssetforthonlythree
agentsofproduction.
Coordination or profit is a labor
Coordinationorprofitisalabor
cost.
yThecostapproachbuildstothe
dateofappraisal.Theincome
approachdiscountstothedate
ofappraisal.Theprofitinthe
f
i l Th
fit i th
incomeapproachisnotthesame
asprofitinthecostapproach.
yProfitcanbederivedandeven
appliedasapercentageofdirect
costs, direct & indirect costs, or
costs,direct&indirectcosts,or
direct,indirectcostsandland
value.However,theprofitor
coordinationisonlyattributable
t th i
totheimprovements.Ifthe
t If th
improvementsaredestroyed,the
profitisalllost.
WhyDoAppraisersHatetheCost
Approach?
• M
Manythinkofthebreakdownmethodofdepreciation
thi k f th b kd
th d f d
i ti
andequatethatwithacostapproach.
• Themarketdoesconsidercost.
The market does consider cost
• Youmustunderstandthefundamentalrelationship
betweenfeasibility(cost)inamarketandmarket
y(
)
value……
– IfpropertiesaresellingwithTRUEeconomicprofit(over
what is needed to build) construction will be brisk
whatisneededtobuild),constructionwillbebrisk
– Ifpropertiesaresellingforundercost(withsufficient
profit),constructionwillstop
– Asabadmarketrecovers,rentsHAVEtooutpaceinflation
ortherewillnotbemoreproductbuilt.Inotherwords,
pp
marketrenthastoapproachnewfeasiblerents.
• Somehateitbecauseitishard&manyclientswillnot
Copyright Ted Whitmer. All rights reserved.
Cost
5
payforit.
Cost
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Cost
Chapter 2
Depreciation
Depreciation is defined as loss in value from all sources. Accrued depreciation is considered to
be the difference between value of improvements and the cost of improvements, with all profits
included. The terms are often used interchangeably.
Depreciation overview
¾ Types of depreciation
ƒ a. Physical
ƒ b. Functional
ƒ c. External
1. in the building, wear & tear
2. outside of the buildings
3. in the building
Answer: A, C, B
¾ Curable vs. incurable
A roof will definitely be replaced in 9 months, is the roof curable or incurable?
INCURABLE, IT IS A TEST OF ECONOMIC FEASIBILITY
Focus: Not can or will it be replaced or cured, but as of the date of the
appraisal is it economically feasible.
¾ Items that look like depreciation, but are not
An overhead crane in a building of 10,000 sf would increase rents 75¢ psf per
year (Ro = 12%), would cost $70,000 to add ($65,000 if in new construction &
$50,000 when the building was built). What type and how much depreciation is
it?
NONE, THE VALUE ADDED OF $62,500 ($10,000 X .75 / 12%) DOES
NOT JUSTIFY PUTTING THE CRANE IN A NEW BUILDING AT A
COST OF $65,000. THEREFORE, IT IS NO OBSOLESCENCE.
¾ Methods to estimate depreciation
o Sales
Formula: Cost new minus (sale price minus land value) = depreciation
Depreciation divided by Cost new = % depreciation
A sale sold 1 year ago for $450,000 and the land value was $150,000. The structure
was 4,000 sf and would cost $90 to build now, $70 when built, and $80 as of the sale
Copyright Ted Whitmer. All rights reserved.
Cost
7
Cost
date. What is the indicated depreciation assuming land values increased 10% and the
market is stable?
BUILDING VALUE = $450,000 - 150,000 = $300,000
$ DEPRECIATION = (4,000 X $80 psf) - 300,000 = $20,000
% DEPRECIATION = $20,000 / 320,000 = 6.25%
o Economic age-life
Formula: Cost x effective age/total economic life
A 5 year old building would cost $50 psf to build new, has an effective age of 4 years
and a remaining life of 40 years. What is the indicated depreciation?
$50 X 4 / (40 + 4) = $4.55 psf
USE THE TOTAL ECONOMIC LIFE, NOT THE REMAINING LIFE.
(REMAINING LIFE + EFFECTIVE AGE)
o Modified economic age-life
Cost Formula: [(Cost - curables) x effective age/total economic life] + curables
A 10 year old building is in need of paint and new wallpaper (because of design).
The paint is 50¢ psf and the wallpaper 75¢ psf of building area. What is the indicated
depreciation if cost new is $40 psf, and the building has a remaining economic life of
35 years?
[($40 - 1.25) X 10/45] + $1.25 = $9.86 psf
Copyright Ted Whitmer. All rights reserved.
Cost
8
Cost
o Breakdown
1).
Physical curable
2).
Physical incurable short-lived Cost of short-lived items x age/life
3).
Physical incurable long-lived Total reproduction cost
- physical curable
- cost of physical incurable short-lived items
Remaining cost after physical curable & cost of short-lived items
X actual age/total physical life
Physical incurable long-lived
4).
Functional - All forms
3A is considering the
item if curable &
3B is considering the
item as though it is
incurable.
You scratch out the
highest value & use
the lowest between
3A and 3B.
Line 4 is a
subtraction & usually
is the value of the
“correct” item, or the
one that is
functionally correct.
5).
External
Cost to cure
(1) Cost of existing item (if in the improvements)
(2) - physical depreciation previously charged (this is the physical
depreciation taken off physical incurable short-lived or the physical
incurable long-lived; the depreciation is deducted to avoid double
counting)
(3A) + cost to cure (removal costs + cost to add, renovate, etc.
- salvage value of item removed), OR
(3B) + PV of loss from item (if it remains; this is the present value of the
loss due to extra expenses or lost occupancy. Offset any loss by value
a superadequate item may contribute to the improvements.)
[Go with the smaller of the two, above.]
(4) - value of the correct item (This is the value of an item that is not in
a building but should have been included in the construction of a
building as of the appraisal date or the correct item’s value (less
depreciation). For example, assume a building needed a service door
and the door would have cost $400 when building a new building,
but will cost $1,000 to add to the existing building. The functional
obsolescence is the cost to cure minus the cost if is a new building.)
a). PV of total loss - loss to land
b). Io loss to building / RB
c). (Io loss to property / Ro) - Loss to land
d). Discount loss over specified period & allocate appropriate loss to the
land
e). Paired sales analysis
Relationship between depreciation and other approaches
¾ Older properties with more depreciation tend to have higher Ro, higher OER and lower
GIM's, until the buildings contribute little value then because of low income but high
(possibly) land value, the Ro becomes small, OER high, and GIM high.
¾ Higher depreciation can show up in sales comparison by larger age/condition
adjustments.
Adjustments in the cost approach
Do not forget bottom-line adjustments for present worth of excess rent (add) or present value of
below market rent (subtract). The value of intangibles or personal property may also be added.
A cost approach generally results in a fee simple value without adjustments. If the appraisal is to
estimate another interest such as a leased fee or leasehold estate, then an adjustment is necessary.
Copyright Ted Whitmer. All rights reserved.
Cost
9
Cost
Depreciation
„Breakdown
„
„Physical
„curable
Economic Agelife
„
„incurable
„short-lived
„long-lived
„
„Functional
„Universal
format
1.
2.
Cost new of existing
- depreciation
charged
3A. + cost to cure, or
3B. + value of loss
4. - cost if installed new,
or + value added by „
item, etc.
„External
Cost x Effective
age/Total economic
life
Modified
Economic Agelife
„
„
Curables &
Incurables
[(Cost - curables) x
Effective age/Total
economic life] +
curables
Extraction From
Sales
1
„curable???
2
„incurable
3
S.P. - land value
Cost - building value
Depreciation/Cost
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Cost
10
Cost
Depreciation
z
Some buildings depreciate significantly at first and
others at the end of the economic life
Vo as a
% of
cost
C
Vo = 100% of cost
B
A
Vo = 0% of cost
Age of
property
Depreciation for a Corporate Headquarters,
Many Special Use Properties & Many
Houses
z Vo is less than 100% of cost at construction
Vo as
a % of
Cost
Vo = 100% of cost
Obsolescence due to
“overimprovement” or due to
use of market value definition
Vo = 0% of cost
Age of
Property
Copyright Ted Whitmer. All rights reserved.
Cost
11
Cost
1
Likely Depreciation of Improvements Over
Time
z
You must determine where an improvement is in
relation to the deferred maintenance
maintenance.
Vo = 100% of cost
Vo as
a % of
Cost
Average over long
period of time
Money spent on
curables over time
If no $ is
spent
Vo = 0% of cost
Age of
Property
Depreciation With Renovation
z
This assumes the renovation costs were
reasonable.
bl Note
N t the
th life
lif iis extended.
t d d
Vo = 100% of cost
Vo as a
% of
Cost
Renovation
New
depreciation line
Average over
a long period
of time
Vo = 0% of cost
Age of
Property
Copyright Ted Whitmer. All rights reserved.
Cost
12
Cost
2
Depreciation Of Components
z
Not all components of a building depreciate over the
same life
Vo as
a % of
Cost
Vo = 100% of cost
“Skeletal Structure” or total physical
life
Economic Life of all
improvements
Items that last
50% of total life
Items that last
<50% of total life
Vo = 0% of cost
Age of
Property
Copyright Ted Whitmer. All rights reserved.
Cost
13
Cost
3
TREATING DEPRECIATION IN THE OTHER APPROACHES
Physical curable
The easiest way to account for physical curable depreciation in the sales comparison approach is to add all curable
physical depreciation to the sale comparables. This requires researching the anticipated deferred maintenance of the
buyer and seller of each comparable property as of the date of sale. The subject should be first analyzed as though it
has no deferred maintenance (physical curable). After the value of the subject is reached ignoring physical
depreciation, an appraiser deducts the physical curable from the indicated value derived earlier that ignored curable
items. (This works for all curable depreciation. Also, it is advisable to do this because there are so many different
conditions of property in the universe of sales. This makes it easy to reuse sales and reach consistency.) One more
note. If curable is significant there may be a profit added to the physical curable to entice a buyer to purchase.
Sometimes the dollar amount is not the critical decider if profit is added, but the time and effort needed to correct
deferred maintenance by the buyer. For example, an apartment complex may need a complete roof, it may have
significant cost, but there is little effort in calling a roofer so little profit may be attached to the problem. If the effort
is significant, profit should be added, if the market recognizes it.
In the income approach, develop the rents, vacancy, expenses and capitalization rate as though there is no curable
physical, derive a value then subtract the curable.
In the sales comparison approach add all curables present in the sales to the sales, analyze the subject as though
there is no physical curable and deduct all of the physical curable estimated. Alternatively, if all sales have similar
physical curable obviously you could just derive a value for the subject and it would include the physical curable, no
deduction would be necessary. If there are varying amounts of curable then an appraiser could adjust the difference
in curable between the comparables and the subject. This exercise is unnecessary if all curable items are added to the
comparables and then all the subject curable physical is deducted at the end of the process.
Physical incurable
In the sales comparison approach, sales are adjusted for age and condition. This should account for any physical
incurable taken in the cost approach. In the income approach, the rents, vacancy, expenses and rate use to capitalize
the net income should reflect the age and condition and thus the physical incurable.
Functional Line 3A (Curable Functional)
The following applies if line 3A (curable) is the lowest between 3A and line 3B (incurable).
You deduct line 3A in the income approach and usually in the sales comparison approach. The reason was set out in
the discussion of physical curable. The income approach should always be developed as though there is no
functional obsolescence represented in 3A. All rents, vacancy, expenses and rate of return would be developed as
though there is no functional curable and then the amount would all be deducted at the end of the process.
Functional Line 3B (Incurable Functional)
Incurable functional obsolescence would be built into the income approach by either lower rents, higher vacancy,
higher expenses or higher cap rates. All of the previous would cause a lower value. Remember the appraiser used
line 3B only if it is lower than line 3A (if curable). Therefore, this is built into the income approach. Incurable
functional obsolescence would typically be deducted in the sales comparison approach unless the comparables have
the same characteristic (functional obsolescence is in the sales and thus is represented in the sale price.).
External Obsolescence
The external obsolescence would be built into an income approach by way of decreased rents or occupancy, higher
expenses and higher capitalization rates. An exception to this is if the external obsolescence is curable or temporary.
An appraiser may develop an income approach as if the problem doesn’t exist, then deduct the loss as a bottom-line
item. The sales comparison approach should reflect external obsolescence if the loss is from market conditions and
no bottom-line deduction would result. An exception would be if the problem in the subject is locational and not a
market loss. The analysis could be as though there is no problem, then the present value of the problem deducted.
However, this may also show up in a location adjustment, etc.
Copyright Ted Whitmer. All rights reserved.
Cost
14
Cost
Chapter 3
Land Value
Land Value Estimate
1. Sales comparison
2. Allocation
3. Extraction
4. Land residual
5. Ground rent capitalization 6. Subdivision analysis
Note: Some authors treat the methods 4 – 6 above as an “Income Approach” and have four
methods to value land. The land residual, ground rent capitalization and subdivision analysis
are subsets of the income approach.
Methods to estimate land value
¾ Sales comparison
¾ Allocation - Results in a percentage to apply to a total value.
¾ Extraction - Sale price minus improvement value, as of the date of sale. Results in a
dollar value.
Should the extraction of sale price minus improvement value be as of the
appraisal date or sale date? Answer: Sale date.
(Try not to use cost, but value; and extract as of the date of sale).
You may have to combine extraction with sales comparison. For example, the
test may have partially improved land where the improvements are extracted
from the sales price. Then the indicated land value is put into an adjustment
process with other unimproved sites.
¾ Land residual
You need which of the following to solve?
a. Io, RL, RB, and land value
b. Io, RL, RB, and building value
c. Io, RL, RB, and total value
d. Io, RL, RB, and mortgage value
Answer: b
Copyright Ted Whitmer. All rights reserved.
Cost
15
Cost
What is the value of land if the RL= 10%, RB= 11%, Io is $25,000 and the
building is worth $100,000?
Value of building =
$100,000
Io =
$25,000
IB (building) =
11,000
IL (land) =
$14,000
Value of land =
14,000/.10 = $140,000
¾ Ground rent capitalization - Is an income approach to valuing land.
Formula: Income to land ÷ Capitalization rate to land
Assume market rent for similar tracts is 50¢ psf per year absolute net and an
appropriate rate for land is 11%, what is the value of a 4.5 acre tract?
(.50 X 4.5 X 43,560) / .11 = $891,000
¾ Subdivision
Which of the following is a general model that expresses the subdivision approach
to valuing land?
a. PV of (Retail values of lots/tracts - expenses - costs - profit) over time
b. PV of (Retail values of lots/tracts - expenses - profit) over time
c. PV of Retail values of lots/tracts over time
d. PV of 50% x sum total retail value of the lots
The answer is (a). To derive the value of land with a subdivision approach, deduct the costs
of infrastructure. To derive the value of a finished subdivision, you would not deduct the
costs of infrastructure, but would assume the money has already been spent. To appraise a
subdivision partially improved or with another one or more phases to be completed, deduct
the unspent monies for costs of infrastructure, but do not deduct costs that are already
assumed to be spent.
Developer's profit - What does it account for?
Management or the money necessary to make the “investment hands off”.
What is the difference between subdivision analysis for vacant land, improved,
and partially improved land?
The inclusion of costs as a line item for land value.
Should construction or carry interest be included as a line item in the DCF?
NO, it is in the overall discount rate! The overall discount rate includes the cost of all capital
including interest on a loan. The deduction of interest in a DCF would double count the
deduction. An appraiser may value a subdivision using an equity residual approach.
However, the total debt service, not just interest would be deducted to result in equity cash
flows. The equity cash flows would then be discounted to present value, resulting in the value
of the equity position. This value would be added to the value of the loan to result in total
value. Most areas of the country use a property model to value subdivisions. Many in
California and other areas of the country use an equity residual model because the data
lends itself to this analysis.
Copyright Ted Whitmer. All rights reserved.
Cost
16
Cost
COMPONENTS OF AN AVERAGE LOT PRICE IN A SUBDIVISION
Return to:
"On" Capital
Return on equity capital
Ongoing
Management
Return on debt capital
Management expense or
Profit Line
(To make the investment a
hands off investment)
All Expenses
Marketing expenses
Commissions
Closing expenses of sale
Overhead
Other expenses
All Costs
Costs of infrastructure
Costs of offsite improvements
Prorated cost of amenities
Raw Land Cost
Underlying raw land value
THE SUM OF THE ABOVE IS THE AVERAGE LOT PRICE THAT RETURNS ALL EXPENSES,
COSTS, RETURN ON CAPITAL, UNDERLYING LAND VALUE, COSTS OF AMENITIES AS
WELL AS THE PRORATED LAND COSTS TO THE AMENITIES TO THE AVERAGE LOT.
NOTE: THE RETURN "OF" IS IN THE RETURN OF EXPENSES, COSTS AND UNDERLYING
LAND VALUE.
Copyright Ted Whitmer. All rights reserved.
Cost
17
Cost
Other considerations
¾ No income approach for land? - Look at the last three methods.
¾ Is the capitalization rate to land always lower than the capitalization rate to the
improvements?
o Subordination to debt: Land leases are often subordinated to debt.
o Long-term level leases: The longer the lease is with level payment the closer the
capitalization rate must be to the yield rate. Therefore, the land capitalization rate
is higher for long-term level leases than building capitalization rates that apply to
leases that are not as long-term and level.
o Tax advantage is all to building: Although the building is a wasting asset, the life
of a building is long and is accounted for by a sinking fund factor. However,
depreciation benefit, which is all to the building, is received annually and is either
1/27.5 = 3.6%/year or 1/31.5 = 3.2%/year. This more than offsets the wasting
away of the building (e.g. a sinking fund factor at 12%, 40 years is only .0013, or
.13%).
o Risk in land higher than buildings: If R = Y - CR, and Y is higher to land than
buildings, then the capitalization rate could be higher.
Problem: What is the value of a subdivision that has expected sales of $1,500,000 over three
years if expenses are 20% of sales (marketing, closing costs, commissions, etc.) and costs of
construction are $750,000, all in the first year? Assume also a management (profit) line of 15%
of retail sales, interest of $25,000 per year, an equity yield requirement of 25%, and a property
yield requirement of 17%. Assume that entitlements cost (last year) $40,000.
The problem is to “value the subdivision.” Therefore, costs will not be deducted, nor will
past costs of entitlements. The interest and Ye are not needed to solve the problem.
1
2
3
Sales
$500,000
$500,000
$500,000
Expenses (20%)
- 100,000
- 100,000
- 100,000
Profit (15%)
-75,000
-75,000
-75,000
Net Proceeds
$325,000
$325,000
$325,000
3 N; 17 I;
325,000 PMT; solve PV [$718,115]
Problem: What is the value of land that can be subdivided into 100 lots with an average sale
price of $30,000 per lot, if the infrastructure costs are $10,000 per lot, expenses are 15% of sales,
and the desired profit is 10% of sales? Assume the market wants a 16% return and the
absorption is 20 lots per quarter.
Copyright Ted Whitmer. All rights reserved.
Cost
18
Cost
100 lots / 20 lots per quarter = 5 quarters
The problem states to “value the land.” Therefore, costs are deducted.
$30,000 x 100 lots / 5 quarters = $600,000 gross sales per quarter.
Expenses & Profit: 25% X $600,000 = $150,000
Net: $600,000 - 150,000 = $450,000
PV of $450,000, 5 quarters: $450,000 PMT; 5 N; 16/4 I; solve PV [$2,003,320]
However, the above value is for the subdivision as though there are no costs of
construction. Two alternatives are to (1) discount the costs over 5 quarters at a safe rate, or
(2) simply deduct the costs of $10,000 X 100 lots = $1,000,000.
It is reasonable to assume almost all costs would be up front, especially with such a short
sell-out and construction period. Therefore, the value is $2,003,320 - 1,000,000 = $1,003,320
for the vacant land. A developer would not earn much if any interest on the money needed
for the costs. If the costs were discounted over the 5 quarters at 16%, there would not be
enough money to complete the subdivision. If the costs are discounted, it must be at a safe
rate.
Copyright Ted Whitmer. All rights reserved.
Cost
19
Cost
Land Valuation
Six (or Four) Acceptable Methods
`
Sales Comparison
`
Allocation
`
Extraction
Income Approach –– The following are all considered an
`
income approach……
`
Ground Rent Capitalization
`
Land Residual
`
Subdivision
Sales Comparison
`
Elements of Comparison
`
At date of sale
`
`
`
`
`
`
Property rights
Financing
Conditions of sale
Expenditures
p
after
Market conditions
At date of appraisal
`
`
`
`
`
Location
Use
Economic
Physical
Non-realty
`
Units of Comparison
`
`
Whole property
Per square foot
`
`
`
Of land area
Of buildable area
Per front foot
`
`
`
Residential
Lake front
Other
Allocation
` The
percentage (%) of total value to land
value
` Is common in residential lots
` Is useful as a rule of thumb
` Example:
` A house sold for $200,000 in a new
neighborhood & the lot was sold for
$40,000. Therefore, the land value is
20% of a total house sale price.
Copyright Ted Whitmer. All rights reserved.
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20
Cost
1
Extraction
Is also called Abstraction. It is the sale price
less contributory building value to result in
a dollar ($) value for the land.
` It is used in areas with older buildings or
b ildi
buildings
representing
i iinterim
i uses.
` Example:
` An older property sold for $500,000 &
the buyer gave the building $50,000 in
value. Therefore, the land is worth
$450,000.
`
Ground Rent Capitalization
`
Is an income approach to valuing land.
` Is useful with leased land along highways,
downtown areas, or other commercial areas
` You should not state in a report: ““Because
the subject in vacant land, an income
approach is not applicable.””
`
Example
`
A site was leased for a restaurant for $5 psf absolute net for
25 years to a fast food chain. Rates of return for similar
leases are 11% - 13%. The value of the site is approximately
$45 psf.
Land Residual
`
The following must be known for a land residual
` Building value
` Building capitalization rate
` Land capitalization rate
` Estimated
E
d Io
I
`
Example:
`
`
A drug store is to be constructed for $2,000,000, inclusive
of profit. The market requires a 9% return on investment for
buildings and 8% for land. What can be paid for a site if the
net operating income is expected to be $270,000/year?
Answer: ($270,000 - $180,000)/.08 = $1,250,000
Copyright Ted Whitmer. All rights reserved.
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21
Cost
2
Subdivision
`
To develop land value:
Estimate retail sales
Estimate absorption period
` Deduct expenses
` Have a line item for profit or put it in the discount rate
` Deduct all development costs
` Discount at rate of return
The above procedure results in how much one could pay for
land.
To value a subdivision, only costs to complete would be
deducted. By deducting all costs above, vacant land value
results.
`
`
`
`
Copyright Ted Whitmer. All rights reserved.
Cost
22
Cost
3
Chapter 4
Cost Approach
¾ Reproduction vs. replacement cost
o Reproduction - duplicate
o Replacement - substitution, replicate
¾ What is the difference between the two costs?
Answer: Only superadequacies. Build deficiencies into reproduction or replacement
cost.
If a house has a 5 ton A/C unit and the market requires a 10 ton unit, do you cost
out a 5 or 10 ton unit for reproduction cost? Replacement cost?
Answer: You cost the 5 ton unit regardless of using reproduction or replacement
cost.
When is original cost relevant to estimate cost?
Never, use cost as of the appraisal date.
When is original cost relevant to test depreciation?
Never, use cost as of the appraisal date.
When is original cost relevant to measure depreciation?
Never, use cost as of the appraisal date.
¾ Types of cost - direct, indirect & profit.
¾ Methods to estimate cost -The methods to estimate cost from most to least accurate.
o Quantity survey – A detailed breakdown of cost
o Unit-in-place (segregated cost) – Costing systems, such as framing, plumbing, etc.
o Comparative unit (calculator method) – Done by square foot, lineal foot, etc.
Copyright Ted Whitmer. All rights reserved.
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23
Cost
¾ Indexes & multipliers
Assume a building cost $40 psf when built 5 years ago. Inflation was 4% and
the cost index was 110, and is currently 145. What is the indicated cost new?
$40 x 145/110 = $52.73
A base cost indicates a cost for a building of $50, unadjusted. The time
multiplier is 1.05, the area multiplier is .98, and the height multiplier is .97.
What is the indicated cost?
$50 x 1.05 x .98 x .97 = $49.91
Note: Do not net out the 5% to the –2% & -3%.
¾ Marshall Valuation
o Calculator - includes almost all cost. Does not include financing fees, lease-up
costs, developer’s profit, or other extraordinary fees, but does include architect’s
fee, contractor’s fees, etc.
o Segregated cost - does not include architectural fees.
o Both calculator and segregated include contractor’s profit.
¾ Profit
o Should always be included in cost, even in a poor market. Is as much a cost as
direct or indirect cost.
o Even though it may be expressed as a percentage of either direct costs, or direct
and indirect costs, or direct costs, indirect costs, and land value, it is only
attributable to the improvements.
Relationship between depreciation and other approaches
Older properties with more depreciation tend to have higher Ro, higher OER and lower
GIM's, until the buildings contribute little value then because of low income but high
(possibly) land value, the Ro becomes small, OER high, and GIM high.
Higher depreciation can show up in sales comparison by larger age/condition adjustments.
Bottom-line adjustments for property rights appraised, etc.
Do not forget bottom-line adjustments for present worth of excess rent (add) or present value of
below market rent (subtract). The value of intangibles or personal property may also be added.
Copyright Ted Whitmer. All rights reserved.
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Misconceptions About the
Cost Approach
„ It sets the upper limit of value
„ Investors do not consider the
cost approach
„ You cannot reflect leased fee or
leasehold valuations
„ It should be independent of the
income & sales comparison
approaches
„ It is most useful for special
purpose properties
„ It is not useful for older properties
Copyright Ted Whitmer. All rights reserved.
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25
Cost
Cost Approach Inconsistencies
(
(Not
Support
S
Problems)
bl
)
The cost does not match
with the quality of the
improvements
… The
e multipliers
u p esa
and
d
other adjustments are
not properly applied
… Lease-up costs are not
accounted for
… The cost is not as of the
appraisal
i ld
date
t
…
The cost manuals do
not reflect current costs
from the local market
(even after all
adjustments)
… Soft costs are omitted
because the owner
built with a small loan
or all cash
… Profit is not included
…
Copyright Ted Whitmer. All rights reserved.
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26
Cost
Cost Approach Inconsistencies
…
Curables do not have
profit or sufficient
profit
fit built
b ilt into
i t th
the
estimate (when
appropriate)
… Depreciation is
inconsistent with highest
& best use as vacant
((and land value))
… Cost is not consistent
with time line
The age of the
improvements is not
consistent with
…
†p
previous
renovations
† the age of
improvements in the
area
† the condition of the
improvements
† after considering all
curables
Copyright Ted Whitmer. All rights reserved.
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27
Cost
Cost Approach Inconsistencies
…
…
…
If leasehold estate or leased fee, is there a bottom-line
or other adjustment?
Are site improvements in the land and the cost?
Overall, does the age of the improvements, the
functionality and market justify the adjustment from cost
expressed by the depreciation?
Copyright Ted Whitmer. All rights reserved.
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28
Cost
Cost Approach Inconsistencies
Appraising on the time line - soft & hard costs
g of completion.
p
Get the date
reflect stage
correct.
…
As Is
Could Be Land Value.
There may be $ spent
for entitlements,
marketing, site
impro ements or eeven
improvements
en
some of the costs. If
materials are on site,
contact yyour client &
find out how to handle
them.
Cost
As Complete, But Not
Stable Occupancy
As Complete
p
&
Stable Occupancy
Occupied &
Finished
Building
The Shell Of a Building
Land
a d value
va ue
Land value
Hard cost to shell & finish
Hard cost to shell
Soft cost to shell & finish & leaseup (marketing, commissions,
tenant improvements)
Soft cost to shell
Copyright Ted Whitmer. All rights reserved.
Profit to completion
29
Profit to completion &
stabilization!
Cost
NOTES
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Chapter 5
Highest & Best Use
Land as though vacant
Property as improved
Four tests of highest and best use
1. Physically possible
2. Legally permissible
3. Financially feasible
4. Maximally productive
Highest & Best Use - that use that produces the highest dollar value to either the site as vacant
(highest and best use as vacant) or to the property as improved (highest and best use as
improved). The highest and best use is not the use that would potentially give the highest yield.
Instead, it is the use that would bring the most value in the open market.
Relationship of market analysis, feasibility & highest and best use
1. Market analysis
a. to identify demand for alternative uses
b. supply and demand analysis to forecast absorption rate and probable rents for:
use no.1,
use no. 2, etc.
2.
Feasibility Analysis
a. to determine respective values on the basis of criterion variables
b. calculation of Io/cash flows and selection of appropriate cap rate/discount rate to determine
property value based on criterion variables for:
use no. 1,
use no. 2, etc.
[Note: Market analysis & feasibility analysis focus on predefined uses]
3.
Selection of Highest & Best Use
a. the use resulting in the maximum value
b. specification in terms of use, timing, and market participants (i.e. user of the property, equity
investor, debt investor)
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¾ Highest & best use of land as though vacant
o Purpose of highest & best use analysis as though vacant
ƒ to determine potential, rather than actual use any building can be
demolished
ƒ to estimate a separate land value
ƒ identify comparable sales of vacant land
o The appraiser should determine the highest & best use of a site as though vacant,
even if there are improvements on the site. They are ignored in the analysis.
¾ Highest & best use of property as improved
o Purpose of highest & best use analysis as though vacant
ƒ identify the use that maximizes the dollar return
ƒ help identify comparable properties
o The appraiser should determine the highest & best use of the property as
improved regardless of the highest & best use as though vacant. The objective is
to determine the use that the seller would get the most money with the
improvements in place and regardless of the highest and best use as though
vacant.
o The value as though improved may be lower than as vacant. For example, the
improvements may have a negative value due to environmental problems or they
may be at the end of their economic life.
¾ Criteria in highest & best use analysis
o The four tests of highest & best use
ƒ Legally permissible
ƒ Physically possible
ƒ Financially feasible
x
Highest capitalization rate wins?
Problem: When would a use have a higher capitalization rate indication than
another use, yet the highest and best use be for the use resulting from the lower
capitalization rate? For example, as an office the property would result in an Ro =
10%, but as retail the property would have an Ro = 11%. When would the
highest and best use be for office even though the capitalization rate is higher for
retail?
Solution:
1. Risk
2. Yield
ƒ
Maximally productive
o The four tests apply to both "as vacant" and "as improved."
Copyright Ted Whitmer. All rights reserved.
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32
Cost
¾
Testing highest & best use
1. Highest and Best Use of Land as Though Vacant
a. Single-Family Residence
Market Value
Cost to construct new
Developer's fee
Land value
The 4,600 sf house should be built.
5,000 sf
$500,000
-375,000
-50,000
$75,000
4,600 sf
$450,000
-320,000
-45,000
$85,000
b. Income-Producing Use
Restaurant Use
Potential Io
$100,000
Overall capitalization rate
13%
Capitalized Io
$769,000 (R)
Development costs
-500,000
Residual land value
$269,000
The development should be for restaurant use.
Other Retail Use
$120,000
12.5%
$960,000
-700,000
$260,000
c. Alternative Approach
Heavy Industrial
Service Center
Cost to build
$500,000
$890,000
Io
70,000
110,000
IB (12%)
-60,000
-106,800
IL
$10,000
$4,000
VL (10%)
$100,000
$40,000
The property should be developed with heavy industrial.
Office WH
$600,000
75,000
-72,000
$3,000
$30,000
2. Highest and Best Use of Property as Improved
a. No Capital Expenditure
Storage
Gross income
$20,000
Vac & coll loss (5%)
-1,000
Expenses
-5,000
Io
$14,000
÷ Ro
10%
Value
$140,000
The property should be marketed for storage.
Industrial
$40,000
-2,000
-23,000
$15,000
11%
$136,000
b. Capital Expenditure Required
Apartments
Apartments
after Renovation
Io
$125,000
$150,000
Ro
12.5%
11.5%
Capitalized Io
1,000,000
1,300,000 (R)
Conversion costs
$000,000
-300,000
Value
$1,000,000
$1,000,000
Further analysis would be necessary to determine the long-term impact by not renovating.
This analysis shows either to renovate or not, the values are equal.
Copyright Ted Whitmer. All rights reserved.
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¾ Special situations in highest & best use
o Single uses - e.g. when market demand is sufficient for one large office building
o Interim uses - use may change in the foreseeable future
o Legally nonconforming uses - are legal, but do not currently conform to zoning
o Uses that are not HBU - many existing improvements
o Multiple uses - parcel with more than one use
o Special-purpose uses - appropriate for one or a limited use, e.g. church
o Speculative HBU vs. HBU for speculation – in the first one doesn’t know the
ultimate use a property will be put to. In the second, the use is defined but the
timing (when) is not.
o Excess land & surplus land - excess land is an economic unit & may be sold off;
surplus land cannot be sold off because of the layout of the improvements
¾ Other considerations
o To demolish or not to demolish test
ƒ If the value of the land as vacant is greater than the value as improved minus
demolition costs, then demolish. If not, do not demolish.
¾
o To renovate or not to renovate test
ƒ If the value of the property is greater after renovation than the value “as is” plus
renovation costs, then renovate. The costs to renovate must include a sufficient
profit. If not, then do not renovate.
o Negative values
ƒ Land
ƒ Improvements
ƒ Property
ƒ Leaseholds
Problem: The value of land as vacant is $150,000. The toxic waste clean up is
estimated at $350,000. What is the value of the property assuming the owner is
liable for the clean-up?
Solution: No more than a negative $200,000.
Note: If a value is negative, don't report a zero value. It is both incorrect and
misleading.
o The underlying land value in a value in use of a property; highest and best use as
vacant?
Problem: A church located on a downtown block wants to sell its property to a
smaller church and build on a larger campus (site). You determine the highest
and best use of the site is for a 60-story office building and would be worth
$5,000,000. The whole property as a church is worth $2,500,000. How should
you value the land for a value in use appraisal?
Copyright Ted Whitmer. All rights reserved.
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Answer: The land should be valued consistent with the use defined for the
property (as a church site). However, it would be prudent to report the value of
the site as vacant and in its highest and best use.
o Assuming similar highest and best use as improved and identical structures (e.g.
houses in different subdivisions, gas stations, fast food stores), which buildings
are worth more, those on a higher or lower valued sites?
Problem: Assume you are appraising 30 gas stations with exact construction
details. Are the improvements likely to be worth more, less, or equal value on
inferior versus superior sites?
Answer: The improvements on the inferior sites are likely worth more than on
the superior sites (assume no superadequacies exist). Gas stations on superior
sites often have a shorter economic life and considerable money is spent to update
the improvements for competitive reasons. If the station is closed, a purchaser is
more likely to destroy the improvements on a superior site but renovate and use
the improvements on an inferior site.
Problem: Assume a site can be purchased for $500,000 and may be developed with either retail
or office. Io if retail will be $250,000, and construction costs will be $2,000,000. Io if office
will be $225,000, and construction costs will be $1,900,000. Retail rents are expected to
increase 4.5% and office rents 4.75%. Terminal capitalization rates for retail are 11% and are
10.75% for office. Which development, if any is appropriate for the subject? What are your
considerations and criteria?
Land value
Cost
Total
Io
Overall cap rate
Terminal cap rate
Retail
$500,000
2,000,000
$2,500,000
Office
$500,000
1,900,000
$2,400,000
$250,000
10%
11%
$225,000
9.38%
10.75%
Although rents increase 4.5% (retail) & 4.75% (office) the yield for retail would be somewhat less than 10% + 4.5%
= 14.5% and less than 9.375% + 4.75% = 14.1% for office because the terminal capitalization rates exceed the
going-in capitalization rates. [Y = R + CR if both income & value increase at the same rate (CR). However, the
terminal cap rates are higher than the going-in cap rates. Therefore, the yields will be less than the sum of the cap
rate + rental increase per year.] It would be difficult to decide between the two given the information because it is
not clear if profit is in the costs given, what the terminal capitalization rates apply to, and the appropriate market
yield for office or retail.
Copyright Ted Whitmer. All rights reserved.
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35
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Special Purpose
Property Definition:
|
Economically
Economically,
suitable for only
one use
|
Therefore, many
use “use value.”
(Because there is a
l k off sales
lack
l and
d
income data, the cost
approach becomes
the default.)
|
In property tax the
result is to shift the
burden of proof of
functional
obsolescence to the
owner.
Copyright Ted Whitmer. All rights reserved.
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Highest & Best Use Problem
A corner tract with an acre, zoned R-1. What is the highest & best use and market value of the property?
Fact: The market would accept the property as a commercial location and would pay more than if it is a
residential property.
Fact: There is a good chance the zoning can be changed, the area is in transition.
Fact: The access is average to good for a commercial property. The property is on a road with a high
traffic count and is not suitable for new residential development.
Fact: There is an old house occupied on the property that has an elderly couple living in it. The couple has
lived there for 30 years and has no interest in moving.
Fact: The house would cost $3,000 to remove, and the land would be worth at least $250,000
with three entities expressing interest at that price and if vacant and zoned C-1. Similar sites have
sold over the past three years for $190,000 to $225,000. The zoning change should cost $10,000
and should take 2 months. It would sell for $100,000 as a residential property.
Go through the tests:
Legal
Physically possible
Financially feasible
Maximally productive
What is the highest and best use and the value?
Solution: The problem does not center on the couple not wanting to move. The market value
definition assumes a willing buyer and seller. The property is currently in conformity with
zoning as a residential property. The 2 months to get the zoning change would be no problem
since it could be included in the construction period. Assuming the zoning change could be
accomplished, the highest and best use would be to sell as a commercial tract to be developed at
least two months out. The value would be $250,000 - $3,000 (to remove the house) - $10,000 (to
get the zoning change) – the risk premium that zoning change would not go through + the
premium that the tract could finally sell for given the activity expressed in the problem with
various entities wanting the property. The sales prices in the past merely show a rising market.
An appraiser should reflect the higher price in the analysis and not merely appraise at past sale
prices.
Copyright Ted Whitmer. All rights reserved.
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37
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NOTES
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Chapter 6
Market Analysis
Market Research in Appraisal
¾ Market Research Scenario 1 - A Site in Search of a Use or Market
™ Productivity analysis - Subject attributes
™ Market activities - Supply & Demand
™ Appraisal Analysis - 3 approaches
™ Use or value
¾ Market Research Scenario 2 - A Use or Market in Search of a Site
™ Market activities - Supply & Demand
™ Productivity analysis - Subject attributes
™ Appraisal Analysis - 3 approaches
™ Site & value
¾ Market Research Scenario 3 - Real Estate as an Investment Alternative
™ Investment/appraisal analysis - 3 approaches
™ Market activities - Supply & Demand
™ Productivity analysis - Subject attributes
Levels of Market Analysis
¾ Inferred vs. fundamental analysis - Inferred analysis is trend analysis & is an
attempt to estimate future changes in value by looking at past market behavior.
Fundamental analysis goes past trend analysis, forecasting demand based upon
segmentation of broad demographic & economic data to reflect the subject’s specific
market. A & B, below, are inferred and C & D, below, are fundamental.
¾ Levels of study
A Least. Is general & descriptive, not subject-specific. Is based on
historical data, not future projections.
B Employs area wide data on general property class. The projected
conclusions are more subject-specific, & the timing projections are based
on interpretation of market wide data on the property type.
C A&B uses historical absorption rates, C uses future-oriented forecasting
techniques. Future demand & absorption are forecast by projecting the
growth of population, income & employment. It provides detailed
submarket data to base projections as well as a competitive ranking for the
subject.
D Is the most detailed. May also include surveys and advanced techniques.
Copyright Ted Whitmer. All rights reserved.
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Situs process
1. ID of activities in the area
2. Study of nature of associations between activities
a. Dominant use/subordinate use
b. Dominant use/ancillary use
c. Codominant use(s)/satellite uses
3. Analysis of accessibility of site
a. Macro-level accessibility
1). Major economic activities
2). Associations between these & related activities
3). Relationship of activity center to major traveled roadways
b. Micro-level accessibility
1). Linkages
2). Movements
a). Assembling
b). Dispersive
c). Trapping point
d). Random
4. Evaluation of impact of total area on the site use
a. Physical environment
b. Social & cultural environment
c. Psychological environment
d. Economic environment
e. Institutional & political
Urban Structure – Ways to view or study.
Concentric zone – A series of concentric circles from a downtown area or other focal
point.
Sector or wedge model – Think of a pizza with the pieces cut in an irregular pattern. This
is the concept that property uses often are developed in a certain pattern from a downtown
area or other focal point.
Copyright Ted Whitmer. All rights reserved.
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Multiple nuclei model – Many urban areas, such as Houston, have many large office and
other business areas other than just the downtown development. The multiple nuclei is used
to categorize and study uses from more than one focal point.
Axial (Radial Corridor) model – Uses are studied and explained based upon their
proximity to transportation corridors such as a river, rail, highway and other byways.
Economic Base
¾ Economic base is the sector of the economy that exports goods or services and imports
money into an area.
¾ Demand analysis
9 ID base components of economy
9 Determines change in base employment
9 Estimates an employment multiplier
9 Develop a population or employment forecast
9 Develop a real estate demand forecast
Ratios, multipliers, quotients & other relationships in market analysis
1. Local employment % in industry
e = Local employ in industry / Total local employment
2. National employment % in industry
E = National employment in industry / Total national employment
3. Location quotient (If >1, then the industry is basic and imports money &
exports goods or services)
LQ = e / E
4. Percentage of basic employees
(LQ - 1.0) / LQ = % of basic employees in industry
5. Number of basic employees
Total employed in industry x % of basic
6. EB multiplier (Employment to basic employment)
Total employment / Basic employment
Basic employment x EB multiplier = Total employment
7. Population/employment ratio (PE)
Total population / Total employment
Copyright Ted Whitmer. All rights reserved.
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8. To forecast total population
Forecast total employment x PE ratio
9. To forecast total employment
Forecast basic employment x EB multiplier = Forecast total employment
10. Total employment
Basic + nonbasic employment = total employment
11. m = Number of jobs created by a basic job
Nonbasic employment / Basic employment
12. Population multiplier = reciprocal of % population in workforce
Estimating demand - future in an area
¾ Retail
1. ¨ in households in market area
2. x average household income
3. x % of income for retail
4. divided by sales psf per year
¾ Office
1. ¨ in office employees over given period
2. x sf of office per employee
3. x capture rate of submarket
¾ Housing
1. ¨ in households in area (population divided by persons per household)
2. + demolitions
3. - (actual - normal vacancies)
4. - (actual - normal units under construction)
Existing buildings and demand
¾ Existing Shopping Center
Market Analysis Process
Step 1
¨ in households in market area
Step 2
Delineate the market area
Step 3
Forecast demand
A. 4cast households
B. Est. mean/median income & total income
C. % household income spent on retail
D. % of retail in subject type property
E. Repeat above for secondary market
F. Determine total demand in market
G. Est SF by dividing F by sales PSF
H. Adjust for vacancy (add)
Step 4
Measure competitive supply
Step 5
Analyze market equilibrium/disequilibrium
Step 6
Forecast subject capture
Copyright Ted Whitmer. All rights reserved.
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¾ Existing Office
Step 1
Step 2
Step 3
A.
B.
C.
D.
Step 4
Step 5
Step 6
Market Analysis Process
¨ in households in market area
Delineate the market area
Forecast demand
Trend analysis using inferred demand
Fundamental analysis using segmentation
1. 4cast: workplace in office, employment by occupational
category & multiply the % in category by employees
2. Estimate size of workforce in subject class of space
3. Estimate the space per employee
4. Multiply 2 x 3
5. Adjust for normal vacancy
Conduct fundamental analysis by ratio method
e.g. 1. total sf in class A/total employment = sf per worker
2. forecast total employment change
3. 1 x 2 is total demand over time
Reconcile the results
Measure competitive supply
Analyze market equilibrium/disequilibrium
Forecast subject capture
¾ Existing Apartment Complex
Market Analysis Process
Step 1
¨ in households in market area
Step 2
Delineate the market area
Step 3
Forecast demand
A. Trend analysis using inferred demand - Data on general growth,
market occupancy, rent trends, & subject history
B. Fundamental analysis using segmentation
1. Estimate current & forecast population
2. Estimate current & forecast average household size
3. Segment # owner & renter occupied
4. Segment # households by inc levels to get % to afford
5. Adjust for normal vacancy
Step 4
Measure competitive supply
Step 5
Analyze market equilibrium/disequilibrium
Step 6
Forecast subject capture
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COMMON RATIOS & MULTIPLIERS - EXAMPLE
Population in area
Employment in area
Basic employment in area
Employment in mining
Mining in country
Forecast basic employment change
50,000
30,000
10,000
3,600
5%
5,000
e (Local employment % in industry) = 3,600 / 30,000 = 12%
E (National employment % in industry) = 5% (given)
Location quotient (mining) = 12% / 5% = 2.40
EB multiplier (Total employment / basic employment) = 30,000 / 10,000 = 3
% of basic employees in industry = (2.40 - 1) / 2.40 = 58.3%
PE ratio (Population to employment) = 50,000 / 30,000 = 1.67
Forecasting:
Total employment:
Total population:
5,000 x 3 = 15,000
15,000 x 1.67 = 25,050
Note:
1. Basic employment x EB multiplier x PE ratio = Population
(This can be used for change in basic employment as well as point in time analysis).
2. Forecast population = Forecast employment growth x PE ratio
SUBDIVISION LOTS
(Also homes, apartments, duplexes, mobile homes, timeshare, condos, etc.)
Keys: 1.
2.
3.
4.
5.
6.
7.
Population change per year or quarter, etc.
% to live in property type (e.g. mobile homes, single-family, etc.)
Monthly payments (inclusive of taxes & insurance)
% of households that can afford
Factor in current supply
Factor in competitive position of subject
Capture rate
Problem:
Population increase:
1997 to 2002 = 35,000 persons
Median household income:
$35,000
25% ± $5,000 of median ; 50% ± $15,000 of median ; 75% ± $25,000 of median
Average household size:
2.75 persons
% single-family units:
60%
Existing supply homes:
500 units
Existing supply of home under construction:
100 units
Existing single-family lots:
750 lots
Typical lot value as % of total value:
22%
Capture of subject subdivision:
20% of the market
Proposed subdivision:
400 lots from $20,000 to $35,000/lot
Mortgage terms: i = 8%, n = 360 months, LTV = 90%, Qualify at 28% total PITI
Taxes are based on $20 per 1,000 of value and insurance on .75% of total home value
Copyright Ted Whitmer. All rights reserved.
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Solution
Housing units demanded:
Housing units per year:
35,000 ÷ 2.75 x 60% = 7,636 single family units
7,636 ÷ 5 years = 1,527 per year
City wide supply:
Duration of supply:
500 + 100 + 750 = 1,350 lots & houses
1,350 / 1,527 = .88 years, or 10.6 months
Home prices in subject:
20,000 / .22 to 35,000 / .22 = $90,900 to $159,000
Incomes to qualify:
[90,900 x 90% x .0881* + (90,900 x .0275**)] /.28 = $34,700 (R)
[159,000 x 90% x .0881* + (159,000 x .0275**)] /.28 = $60,600(R)
* Rm = 360 N, 8 ÷ 12 I, -1 PV, solve PMT x 12 (.0881)
** Taxes are 2% & insurance .75% of value = 2.75%
% who qualify:
The median income is $35,000 and 75% of the population is
within $25,000 of the median income, or $10,000 to $60,000.
Therefore, 1/2 of 75% is from $10,000 to $35,000 & 1/2 is from
$35,000 to $60,000. This translates to 75% divided by 2, or 37.5%
of the population is in the range of the subject home value.
Lots/homes demanded:
1,527 per year x .375 = 572 units per year
Capture rate:
20%
Absorption:
572 x 20% = 114 lots per year
Sellout:
400 lots ÷ 114 = 3.5 years
Variations:
1.
If the market study is for apartments, etc. (rental units), then instead of mortgage
payments, look at affordability and rental payments that will be made.
2.
Also look for % owner vs. renter, & possibly further segmentation based upon type of
subject property (e.g. high amenity apartments, extended care facilities, etc.
3.
The problem above gives the capture rate (20%) for the subject. You may be asked to
make a judgment call on the test based upon competitive supply.
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RETAIL
Keys: 1.
2.
3.
4.
5.
6.
7.
8.
9.
Households
Average household income
% income spent on retail
% spent in subject type
% retention
Sales required psf
Less existing supply
Less forecast supply
Residual demand
Problem
Households:
Average household income:
% spent taxes
% spent on nonretail
services, recreation, savings)
% of retail sales by subject type
% retention of sales in primary mkt
% supportable in secondary mkt
Sales required psf subject type
Frictional vacancy
Existing retail space
Under construction
Permitted
Change of 1000 over the next 5 years
(Currently 10,000)
$35,000
25%
45% (housing, medical, insurance & professional,
20%
80% (Note: on the test this may be expressed as 20% leakage)
15% (of primary)
$250
5%
250,000 sf (20% in subject type)
50,000 sf (25% in subject type)
40,000 sf (15% in subject type)
Solution
1.
2.
3.
4.
5.
6.
7.
8.
9.
Total income = 11,000 x $35,000 = $385,000,000
Retail sales potential = $385,000,000 x (1 - 25% - 45%) = $115,500,000
Retail sales by subject type = $115,500,000 x 20% = $23,100,000
Sales retention = $23,100,000 x 80% = $18,480,000
Primary sales sf required = $18,480,000 / $250 psf = 73,920 sf
Plus: Secondary sales = 73,920 x 1.15 = 85,008 sf
Plus: Frictional vacancy = 85,008 / (1 - 5%) = 89,482 sf
Less: Existing, U.C., proposed = 250,000x20% + 50,000x25% + 40,000x15% = 68,500 sf
Shortage of space (next 5 years) = 89,482 sf - 68,500 = 20,982 sf
OFFICE & INDUSTRIAL
Keys: 1.
2.
3.
4.
5.
6.
7.
Employment
% of employment in office
Average sf per employee
Capture by subject area
Capture by subject property class (A, B, etc.)
Add existing, under construction (U.C.), proposed
Calculate residual demand
Copyright Ted Whitmer. All rights reserved.
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Problem:
Employment
Population
PE ratio 1.75 to 1
Percent of employees in office
Total office in city
Total Class B in city
Total office in submarket
Occupancy
Total Class B in submarket
Occupancy in Class B
Frictional vacancy
Average space per employee
Est. capture by subject area
Est. % class demand
Office U.C., proposed Class B
Currently 50,000
Expected growth in population over next 4 years is 20,000 persons
20%
1,000,000 sf
550,000 sf
100,000
75% in submarket
50,000 sf
80%
5%
225 sf
25%
50%
25,000 sf
Solution:
1.
2.
3.
4.
5.
6.
7.
Total employment growth = 20,000 / 1.75 = 11,429
Total occupying office = 11,429 x 20% = 2,286 persons
Office demand = 2,286 persons x 225 sf per person = 514,350 sf
Capture in subject market = 514,350 x 25% = 128,588 sf
Total demand for Class B in market = 128,588 sf x 50% / (1-5%) = 67,678 sf
Less: Existing, UC, proposed = (50,000 sf x 20% vacant) + 25,000 sf = 35,000 sf
Residual demand = 67,678 - 35,000 = 32,678 sf needed
Variations:
1.
There may not be a frictional vacancy given. Compute demand without making up a vacancy.
Copyright Ted Whitmer. All rights reserved.
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NOTES
Thispageleftintentionallyblank.
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Chapter 7
Feasibility Analysis
Feasibility involves decisions as to “build or do not build.” Additionally, the quantity and quality
of a project is assessed against the market or a particular client who wants a property built.
Maximum building size on a site
Building size for surface parking
Land area =
X + X (Efficiency ratio)(SF needed per parking space) + Setbacks + Open areas
Stories
SF of rentable per parking space
Solve for X. (Note: X is the gross building area. X times efficiency ratio is NRA)
The above can also be expressed as follows:
Total land area - Setbacks - Open areas
=
X + X (Efficiency ratio)(SF needed per parking space)
Stories
SF of rentable per parking space
Example:
Land area = 75,000 sf
Setbacks = 5,000 sf
Open areas = 4,000 sf
Parking by zoning:
1 space per 350 sf of building (rentable area)
Land requirement:
It takes 300 sf of land to construct 1 space
Building efficiency = 88% net-to-gross (2-story)
75,000 = X/2 + X (.88) (300) + 5,000 + 4,000
350
75,000 - 9,000 = .5X + .75429X
1.25429X = 66,000
X = 52,619 sf (gross building area)
Proof:
52,619 sf bldg / 2 = 26,310 gross bldg footprint
52,619 sf x .88 = 46,305 sf Rentable
Parking spaces required: 46,305 / 350 = 132 spaces
132 spaces x 300 sf per space = 39,600 sf
26,310 sf (footprint) + 39,600 (parking) + 9,000 (setbacks & open area) = 74,910 sf [Note: There
is a slight difference because the amount of parking was rounded]
Note: There are no easy formulas. Algebra is required. Set up the problem and solve for “X” (the unknown). The
solution is based upon one side of the equation representing the available land area that improvements can be
built upon (Total land area - setbacks - other open areas - easements, etc. where no improvements can be placed.)
The other side of the equation represents the improvements as a function of the building or improvement area.
The building area is represented by “X”. Parking is generally a function of building size, or “X”.
Copyright Ted Whitmer. All rights reserved.
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HOW MUCH BUILDING CAN I GET ON THE SITE PROBLEM...
Site has 300 feet of frontage on Commercial Blvd. and is 425 feet deep
Parking will be surface and 325 sf per space is required
Parking requirements are 500 sf per GLA by zoning & the market requires 400 sf per GLA
(The above are minimums)
Open area requirements are 10%, not including setback areas
Setbacks are 10 feet on both sides, 30 feet in the front, and 20 feet in the rear & no improvements may be put on the
setbacks including parking
(No parking or buildings are allowed in the setbacks)
Sidewalk areas will be 15% of the footprint of the building
The building will be 2-story
Solution
1.
2.
3.
The total site area is 300 x 425 = 127,500 sf
The amount in open areas = 127,500 x 10% = 12,750 sf
The amount in setbacks
10 ft
300 ft
10 ft
20 ft
Notice the corners.
Do not count the
corners twice.
The setback area is
(2x10ftx425ft)+
(280ftx20ft) +
(280ftx30ft) =
22,500sf
425 ft deep
30 ft
4.
5.
6.
7.
8.
Therefore, the land that can be built on is 127,500 - 12,750 - 22,500 = 92,250 sf
The equation is as follows.
92,250 sf = 1/2X + (X/400 x 325 sf) + .15/2X
X represents the total size of the building.
The 1/2X is the footprint of the building, or 1/2 of the total rentable area (it is 2-story).
X/400 is the number of parking spaces needed. Use the more stringent, zoning or market. The lower the
number at the bottom of the fraction, the more the parking spaces that will be indicated.
The number of spaces, X/400, is multiplied by 325 sf per space.
The sidewalks will be 15% of the footprint, or 1/2 of the total. Therefore, .15/2 is the percentage of the
total size needed for sidewalks.
Make all the fractions decimal equivalents.
92,250 sf = .5X + .8125X + .075X
1 divided by 2 = .5
325 divided by 400 = .8125
.15 divided by 2 = .075
Combine terms
92,250 sf = 1.3875X
Solve for X by dividing both sides by 1.3875. X = 66,486 sf
Copyright Ted Whitmer. All rights reserved.
Cost
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9.
Check:
66,486 / 2
33,243 x .15
66,486 / 400 x 325
127,500 x 10%
Setbacks
Total
=
=
=
=
=
=
33,243 sf for the footprint of the building
4,986 sf for the sidewalks
54,020 sf for parking
12,750 sf for open areas
22,500 sf
127,499 sf total land area
Measures of investment performance
Use the following investment and returns to calculate the following measures of
investment performance.
Investment = $100,000 (investor wants a 10% return, reinvestment rate = 5%)
Year 1: $12,000
12,000 g CFj
Year 2: $15,000
15,000 g CFj
Year 3: $25,000
25,000 g CFj
Year 4: $110,000
110,000 g CFj 10 i; f NPV [$117,220]
Payback period -
Period the sum of the inflows = the investment.
Strength: Capital recapture focus
Weakness: Ignores time value of $
Year 4: Only $52,000 total dollars are received through year 3.
Profitability index - PV of inflows ÷ investment (PV outflows)
[(Investment + NPV) ÷ Investment]
117,220 / 100,000 = 1.1722
Net present value (NPV) - PV of inflows minus PV of investment
117,220 - 100,000 = $17,220
Note: NPV is the PV of inflows minus the PV of outflows.
Internal rate of return (IRR) - Rate of return where PV of inflows = investment
NPV($) Profitability Index(±1)
IRR(%)
Positive
>1
> discount rate
Negative
<1
<discount rate
$0
1
= discount rate
100,000 CHS g Cfo
12,000 g CFj
15,000 g CFj
25,000 g CFj
110,000 g CFj
f IRR [15.38%]
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Modified internal rate of return (MIRR) - The rate or return where PV of inflows
compounded at a reinvestment rate = PV of the investment.
FV of Invested
Compounded @ reinvestment rate
--------->
---------> --------->
cash flow 1
Investment
cash flow 2
cash flow 3 ...
cash flows @
reinvestment
rate
MIRR is the rate that makes the FV of invested
cash flows = PV of the investment
12,000 g CFj
15,000 g CFj
25,000 g CFj
110,000 g CFj
5 i f NPV 4 N FV [-166,679]
100,000 PV
i [13.62%]
Note: The MIRR is always between the IRR & the reinvestment rate, unless all three are equal. If the MIRR is < the
reinvestment rate, then the IRR is less than the two rates. If the MIRR is greater than the reinvestment rate, then the IRR
is greater than the two rates.
Expected values
The reversion of land is dependent upon three events in the market.
(1) Construction of a mall,
(2) home sales increasing at a higher than current rate, and
(3) a highway will be announced near the property.
There is a 20% chance all three will happen (the value will be $8.00 psf), a 15%
chance (1) and (2) will happen (value $6.00 psf), a 10% chance (2) & (3) will
happen ($5.00 psf), a 20% chance (1) & (3) will happen ($7.00 psf) and if none
occur the value will be $3.00 psf. What is the expected value?
.20 X 8.00
.15 X 6.00
.10 X 5.00
.20 X 7.00
.35 X 3.00
$5.45 psf
Utility functions - Same as above but also assign a utility value. The result of a utility
function is not a value, but is used to rank investment opportunities.
Debt coverage ratio - Ranking investments based upon safety in cash flows as measured by
debt coverage ratio (Io divided by debt service).
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Sensitivity
y analysis
y
y Measures how a change in 1
assumption affects the
analysis
y Examples
{p
projected
j
rental rates
{ vacancy rates
{ expense ratios
{ price
i change
h
y Example- change in Re on
change in gross income
y Example- change in Re on
change in OER
Copyright Ted Whitmer. All rights reserved.
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Scenarios
y Measures sensitivity
y of a p
performance
y
y
y
y
variable to concurrent changes in a group of
variables
{ For example, “pessimistic”, “most likely”
& “optimistic”
p
Expected return - assign a probabilities to
possible outcomes & weight it out
Variance & standard deviation
{ Variance is a measure of degree of spread
among a set of values
{ Standard deviation is square root of
variance
Ù 1 standard
d dd
deviation
i i = 68%
Ù 2 standard deviations = 95%
Ù 3 standard deviations = >99%
{ the higher the standard deviation > risk
Expected PV is weighting out values from
various scenarios
Can use standard deviation with expected
value
al e to establish range of value
al e within
ithin
confidence intervals
Copyright Ted Whitmer. All rights reserved.
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Breakeven ratio
y It is used to determine the
margin of safety that exists
until CF = 0
{DCR = 1
{Re = 0
y BER = (OE + DS) / PGI
y It results
lt iin a % occupancy
to break even
y Note
N t it is
i calculated
l l t d on PGI
& not EGI!!!
Copyright Ted Whitmer. All rights reserved.
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Breakeven point
p
y Point at which EGI = debt
service + expenses
y To derive occupancy:
{BE occupancy =
(OE + DS)/annual rent per
unit
y “Unit” can be an apartment
unit,
u
t, ssf,, cub
cubicc ft,
t, etc.
y You can easily calculate this
once you have the “breakeven
ratio ” Just multiply the ratio
ratio.
by the total units (This is my
suggested way.)
Copyright Ted Whitmer. All rights reserved.
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Absorption
A subdivision has 100 proposed lots that will sell for $40,000/lot. The lot represents
approximately 25% of total home value. Qualify at 2 times household income with income
ranging from $25,000 to $200,000 per family. Given a supply of 300 lots competing with the
subject and 1,000 new families in the next year. How many months should it take to absorb the
subject, assuming 20% of the families qualify for the subject price range, and the subject is in an
average competitive position?
Capture rate = % of total potential market absorbed in the subject = lots in subject sold per period ÷ total
lots in market
Absorption = total families per time period moving into area x % in subject price range x capture rate
100 families X 20% qualify = 200 lots per year
300 lots existing + 100 proposed = 400 lots
Subject capture rate = 100/400 = 25%
Absorption = 200 X 25% = 50 lots per year
Sell Out = 100 lots/ 50 lots = 2 years
Calculation of Feasible Rents
Feasible rents are a function of cost and rate of return. In its simplest form a project is feasible
when the income generated produces the required return on cost. The cost includes direct,
indirect and profit as well as land cost. The rate of return is either to a particular investor, class of
investors or the market in general. Overall rates from sales of existing buildings can be used for
indications of return rates. However, if the properties are older the range of rates may be on the
higher end of the rates that should be used for analysis of a proposed project, unless there are
indications of risk that make the project higher risk than with an existing property.
There are two examples of feasible rent calculations following. One is for a property that leases
90% of gross building area and the other for a property that can lease 100% of gross building
area. Another example of calculation of feasible rents with different rates of increase to various
components is included.
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When Market Rent Exceeds
Feasible Rent
(Good Market Conditions for Building)
y If the rental rates in the market
exceed the feasible rental rate,
then one, two, three or all of the
f ll
following
willll hhappen……
y land values will increase at a very
rapid
p rate ((land owners will take
their cut of the market)
y improvement costs will increase
(subs will take their cut)
y there will be continued
construction (developers will be
smiling)
y rates could increase and this
would cause costs to increase,
slowing
l i bbuilding
ildi (the
( h Federal
Fd l
Reserve gets involved)
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When the Market Softens……
y Feasible rent will exceed market
rent & market rent will decline at a
rapid rate
y Land values will dive & decrease at
a faster rate than will buildings
y The highest & best use of land will
change from ““office”” to ““hold for
p
future office development””
y Land will be a negative carry with
a risky reversion pushed out. The
mechanics of discounting can
cause land to be worth 1/2 in one
d what
day
h t it was th
the dday bbefore.
f
Copyright Ted Whitmer. All rights reserved.
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Feasible Rent Calculation
90% Efficient Building
90% [Is usually 100% for retail & apartment]
Efficiency Ratio (Rentable/GBA)
Cost psf of GBA
Land Cost per GBA
Total Cost - Land & Bldg
$
$
$
Capitalization Rate Range in the Market
Feasible NOI Required per GBA
Feasible NOI Required per Rentable Area
$
$
Expenses:
All expenses expressed as a $ amount
All expenses expressed as a % amount of EGI
Net Effective Gross Income Required on Rentable
Vacancy & Collection Loss as a %
Gross Rent psf of Rentable Area Required
40.00 [If the cost are given in $ overall, convert to psf]
28.31 [Convert land cost to cost psf of GBA]
68.31
11.50% [Use the lower to middle end of market rate range becaus
the building would be new.]
7.86 [This is the Total Cost x Ro]
8.73 [This is above feasible rent on GBA divided by
efficiency ratio]
$
2.58
8.00%
12.30
7.00%
13.22
$
$
Inflation to Land and Building
[Add all expenses given on a $ amount & convert to psf]
[Add all expenses given on a % amount of EGI]
[(Feasible net rent + expenses psf)/(1 - % expenses)]
[Net effective rent required divided by (1 - vacancy)
3.00%
Gross Market Rent psf of Rentable
Expected Growth in Market Rent
$
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Year 7
Year 8
Year 9
Year 10
10.50
7.00%
Market Rent
$11.24
$12.02
$12.86
$13.76
$14.73
$15.76
$16.86
$18.04
$19.30
$20.66
Feasible Rent
$13.62
$14.03
$14.45
$14.88
$15.33
$15.79
$16.26
$16.75
$17.25
$17.77
Is feasible when Market > Feasible
Feasible
The above analysis is simplistic, but illustrates the feasibility problem with every development. The land value may
be derived after an appraisal or be based upon an asking price, etc. The costs include all direct, indirect costs and
profit. This research could take a significant amount of time.
The rate of return used to calculate net operating income needed may be after significant market analysis or may be
based upon capital return requirements to the developer, the debt investor(s) and possibly equity investor(s).
The expense analysis would take considerable study. The above analysis adds all percentage (of EGI) expenses and
dollar expenses. The net effective gross income required is calculated by dividing the Io required plus dollar
expenses by one minus all the percentage expenses added up.
Finally, the gross potential income required is determined by dividing the EGI required by one minus the vacancy
and collection loss rate used.
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The gross income required is compared to the market rental rate which also would require a market study
specifically applied to the proposed property. The feasible rents necessary over time (increases to) could be broken
out to components such as land and building and even more detailed. The market rent would increase depending
upon expectations of inflation and relative price increases for the particular product. If a project is not feasible, the
market rent increases have to outpace feasible rent increases or a property would never be built.
The project is feasible when market rent is equal to or greater than feasible rent. However, because of the lag time
from construction to occupancy, the time to build would be backed off by the construction time anticipated.
Furthermore, the developer would try to prelease or sale much of the property to beat competition to the market.
Feasible Rent Calculation
100% Efficient Building
100% [Is usually 100% for retail & apartment]
Efficiency Ratio (Rentable/GBA)
Cost psf of GBA
Land Cost per GBA
Total Cost - Land & Bldg
$
$
$
Capitalization Rate Range in the Market
Feasible NOI Required per GBA
Feasible NOI Required per Rentable Area
$
$
Expenses:
All expenses expressed as a $ amount
All expenses expressed as a % amount of EGI
Net Effective Gross Income Required on Rentable
Vacancy & Collection Loss as a %
Gross Rent psf of Rentable Area Required
40.00 [If the cost are given in $ overall, convert to psf]
28.31 [Convert land cost to cost psf of GBA]
68.31
11.50% [Use the lower to middle end of market rate range becaus
the building would be new.]
7.86 [This is the Total Cost x Ro]
7.86 [This is above feasible rent on GBA divided by
efficiency ratio]
$
2.58
8.00%
11.35
7.00%
12.20
$
$
Inflation to Land and Building
[Add all expenses given on a $ amount & convert to psf]
[Add all expenses given on a % amount of EGI]
[(Feasible net rent + expenses psf)/(1 - % expenses)]
[Net effective rent required divided by (1 - vacancy)
3.00%
Gross Market Rent psf of Rentable
Expected Growth in Market Rent
$
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Year 7
Year 8
Year 9
Year 10
10.50
7.00%
Market Rent
$11.24
$12.02
$12.86
$13.76
$14.73
$15.76
$16.86
$18.04
$19.30
$20.66
Feasible Rent
$12.57
$12.94
$13.33
$13.73
$14.14
$14.57
$15.01
$15.46
$15.92
$16.40
Is feasible when Market > Feasible
Feasible
Copyright Ted Whitmer. All rights reserved.
Cost
61
Cost
The following is calculation of feasible versus market rent with different component parts of the
land and building changing over time.
Calculation of Feasible Rent With Different Growth (%) Components
Labor
Materials
Indirect costs
Profit
Land
Total cost
Ro from market
Feasible rent
Market rent
Rent increase
Increases-->
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Year 7
Year 8
Year 9
Year 10
$40.00
$15.00
$18.00
$12.00
$20.00
$105.00
9.50%
$9.98
psf
psf
psf
psf
psf
psf
Expected
Increase
3.00%
2.50%
2.00%
1.50%
6.00% [Based upon psf of building area]
psf
[Total cost psf times Ro from market]
$8.50
8.00%
3.00%
2.50%
2.00%
Labor Materials Indirect
$41.20
$15.38
$18.36
$42.44
$15.76
$18.73
$43.71
$16.15
$19.10
$45.02
$16.56
$19.48
$46.37
$16.97
$19.87
$47.76
$17.40
$20.27
$49.19
$17.83
$20.68
$50.67
$18.28
$21.09
$52.19
$18.73
$21.51
$53.76
$19.20
$21.94
1.50%
6.00%
Profit
$12.18
$12.36
$12.55
$12.74
$12.93
$13.12
$13.32
$13.52
$13.72
$13.93
Land
$21.20
$22.47
$23.82
$25.25
$26.76
$28.37
$30.07
$31.88
$33.79
$35.82
Total
$108.32
$111.76
$115.33
$119.05
$122.91
$126.92
$131.09
$135.43
$139.95
$144.64
Ro
9.50%
9.50%
9.50%
9.50%
9.50%
9.50%
9.50%
9.50%
9.50%
9.50%
8.00%
Feasible Market
Rent
Rent
$10.29
$9.18
$10.62
$9.91
$10.96
$10.71
$11.31
$11.56
$11.68
$12.49
$12.06
$13.49
$12.45
$14.57
$12.87
$15.73
$13.29
$16.99
$13.74
$18.35
Feasible
Copyright Ted Whitmer. All rights reserved.
Cost
62
Cost