Tutorial 4, revised

1. What is real estate valuation and why is it important?

• Formal process of determining the value or worth of real property
  • Expert to establish the value of worth of real property

Real estate valuation is used for:

• purchase or sale of a property
• Financing - lender require an accurate valuation of a property before approving a mortgage
• Property tax assessment: used to determine the land tax and rate assessment, based on the assessed value of the property
• Insurance: used for determining the amount of insurance coverage needed
• Annual reporting: valuations used in both private and public sectors

2. How is market value for real estate defined?

International valuation standards:

The estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion.

Thus:

• Buyer and seller both have full knowledge of the properties' condition
• No outside factors affecting the transaction, such as undue pressure

3. How does the cost approach to real estate valuation work and what types of properties is it typically used for?

Cost Approach

• Estimate the cost to replace or reproduce a property
  • Consider factors such as depreciation, obsolescence and physical depreciation
• Typically used as part of the summation method and for existing use valuations

4. What is the income approach to real estate valuation and how is it used to value commercial properties?

• Income approach to real estate is used to value properties that generate income
  • apartment buildings, office buildings, retail centres etc.
• Estimates the property based on it's potential income stream, using method such as the
  • capitalisation method
  • discounted cash flow method

Capitalisation method:

$$CV = \frac{NI}{I}$$

Where the valuer needs to establish:

• the open market rental rate applicable to the property by reference to the market rental evidence $NI$
• the capitalisation rate (yield) through analysis of recent sale evidence. $i$

5. How does the sales comparison approach to real estate valuation work and what types of properties is it typically used for?

Sales comparison <-> Direct comparison

• Used when sales evidence is comparable enough to subject to allow direct comparison.
• Most popular method of valuation incorporated in the valuation of non income producing properties.
  • Works by comparing the subject property to recently sold properties that are similar in location, size condition and other key factors
  • Typically used for residential properties that are not valued based upon their income producing potential

6. What are some of the key factors that affect the value of a property, regardless of the valuation approach used?

Key factors include:

• location
• size
• condition
• amenities

7. Define the terms “Potential Gross Income”, “Effective Gross Income” and “Net Operating Income”. What is the relationship of these terms and how does it affect the valuation of income producing property?

$$\text{Potential gross income} \; (PGI): \; \text{"The total income attributable to real property at full occupancy."}$$

$$\text{Effective gross income} \; (EGI): \; \text{"The anticipated income from all operations of real property adjusted for vacancy and credit losses."}$$

$$\text{Net operating income} \; (NOI): \text{"The actual or anticipated net income remaining after deducting all operating expenses from effective gross income, but before deducting mortgage debt service."}$$

These terms are used to define income streams relating to an income-earning property.

8. What are some common challenges that arise during the real estate valuation process, and how can these challenges be overcome?

• For a direct comparison method, challenge to make adjustments for items that are not comparable
• Incomplete and inaccurate data
• Depreciation/obsolescence, hard to assess accurately and need to apply a depreciation method
  • subjective judgments about property condition or quality
  • assumptions made in the depreciation method
• Changes in market conditions

9. Why is the capitalisation rate also referred to as the "All Risks" rate?

• Because it is the rate that represents all current and future expectations and benefits to be derived from a property
  • include a variety of risks

10. How can technology and data analytics be used to enhance the real estate valuation process, and what new tools and platforms are available to help real estate professionals make more accurate valuations?

• Due to more accurate and timely data on market trends, simple valuations where lots of data is recorded could be automated. E.g. residential properties

1. At what year does the Present Value of an income stream of $100,000pa approach effectively the same as the income stream in perpetuity at the following discount rates:

(a) 15%

$$PV = \frac{100000}{0.15}=\$ 666,666.67$$

(b) 10%

$$PV = \frac{100000}{0.10}=\$ 1,000,000.00$$

(c) 5%

$$PV = \frac{100000}{0.05}=\$ 2,000,000.00$$

(d) 2%

$$PV = \frac{100000}{0.02}=\$ 5,000,000.00$$

2. What does this say about the validity of using the capitalisation rate methodology to the valuation of an income producing property?

• Very incremental changes in the Capitalisation Rate will result in large changes to the present value of the property.

3. If you own a residential property valued at $2,000,000 that has a weekly market rent of $750 and you pay rates and insurance costs of $9,000pa. What is your Reversionary Yield?

$$RY = \frac{750 \times 52}{2,000,000} = 1.95$$

4. Referring to your answers to Questions 1 to 3 above can you explain why residential real estate is not valued using the capitalisation method?

• It is not an income-producing property