3.5.3. Income approach
Income approach is based on the fact that the value of the property in which capital is invested must correspond to a current assessment of the quality and quantity of income that this property is capable of generating.
Capitalization of income is a process that determines the relationship between future income and the current value of an object.
The basic formula of the income approach (Fig. 3.5):
Or where
C (V) - property value;
BH (I) - expected income from the property being assessed. Income usually refers to the net operating income that a property is capable of generating over a period;
K (R) - rate of return or profit - is a coefficient or capitalization rate.
Capitalization rate- rate of return, reflecting the relationship between income and the value of the valuation object.
Capitalization rate- This is the ratio of the market value of property to the net income it generates.
Discount rate- the rate of compound interest, which is applied when recalculating at a certain point in time the value of cash flows arising from the use of property.
Rice. 3.5. Income capitalization model
Stages of the income approach:
1. Calculation of gross income from the use of an object based on an analysis of current rates and tariffs in the rental market for comparable objects.
2. The assessment of losses from incomplete occupancy (renting) and uncollected rental payments is made on the basis of an analysis of the market and the nature of its dynamics in relation to the real estate being valued. The amount calculated in this way is subtracted from the gross income, and the resulting figure is the actual gross income.
3. Calculation of costs associated with the subject of assessment:
Operational (maintenance) – costs of operating the facility;
Fixed – costs of servicing accounts payable (interest on loans, depreciation, taxes, etc.);
Reserves are the costs of purchasing (replacing) accessories for a property.
4. Determination of the amount of net income from the sale of the object.
5. Calculation of capitalization ratio.
The income approach estimates the current value of real estate as the present value of future cash flows, i.e. reflects:
- the quality and quantity of income that a property can bring during its service life;
- risks specific to both the object being assessed and the region.
The income approach is used to determine:
- investment value, since a potential investor will not pay more for an object than the present value of future income from this object;
- market value.
Within the framework of the income approach, it is possible to use one of two methods:
- direct capitalization of income;
- discounted cash flows.
3.5.3.1. Income capitalization method
When using the income capitalization method, income for one time period is converted into the value of real estate, and when using the discounted cash flow method, income from its intended use for a number of forecast years, as well as proceeds from the resale of a property at the end of the forecast period, are converted.
The advantages and disadvantages of the method are determined according to the following criteria:
The ability to reflect the actual intentions of the potential
buyer (investor);
The type, quality and breadth of information on which the analysis is based;
Ability to take into account competitive fluctuations;
The ability to take into account the specific features of an object that influence
on its cost (location, size, potential profitability).
Income capitalization method used if:
Income streams are stable over a long period of time and represent a significant positive value;
Income streams are growing at a steady, moderate pace. The result obtained by this method consists of the cost of buildings, structures and the cost of the land plot, i.e. is the cost of the entire property. The basic calculation formula is as follows:
Or where
C - cost of the property (monetary units);
CC - capitalization ratio (%).
Thus, the income capitalization method is the determination of the value of real estate through the conversion of annual (or average annual) net operating income (NOI) into current value.
When applying this method, the following must be taken into account: limiting conditions:
Instability of income streams;
If the property is under reconstruction or under construction.
The main problems of this method
1. The method is not recommended for use when the property requires significant reconstruction or is in a state of unfinished construction, i.e. It is not possible to reach a level of stable income in the near future.
2. In Russian conditions, the main problem faced by the appraiser is the “information opacity” of the real estate market, primarily the lack of information on real transactions for the sale and rental of real estate, operating costs, and the lack of statistical information on load factor in each market segment in different regions . As a result, calculating the NRR and capitalization rate becomes a very complex task.
The main stages of the valuation procedure using the capitalization method:
1) determination of the expected annual (or average annual) income, as the income generated by the property under its best and most efficient use;
2) calculation of the capitalization rate;
3) determining the value of a property based on net operating income and capitalization ratio by dividing the NPV by the capitalization ratio.
Potential Gross Income (GPI)- income that can be received from real estate with 100% use of it without taking into account all losses and expenses. PPV depends on the area of the property being assessed and the established rental rate and is calculated using the formula:
, Where
S - rentable area, m2;
cm - rental rate per 1 m2.
Actual Gross Income (DVD)- this is the potential gross income minus losses from underutilization of space and when collecting rent, with the addition of other income from the normal market use of the property:
DVD = PVD – Losses + Other income
Net operating income (NOI)- actual gross income minus operating expenses (OR) for the year (excluding depreciation):
CHOD = DVD – OR.
Operating expenses are expenses necessary to ensure the normal functioning of the property and the reproduction of actual gross income.
Calculation of capitalization ratio.
There are several methods for determining the capitalization rate:
taking into account the reimbursement of capital costs (adjusted for changes in the value of the asset);
linked investment method, or investment group technique;
direct capitalization method.
Determination of the capitalization ratio taking into account the reimbursement of capital costs.
The capitalization ratio consists of two parts:
1) the rate of return on investment (capital), which is the compensation that must be paid to the investor for the use of funds, taking into account the risk and other factors associated with specific investments;
2) capital return rates, i.e. repayment of the initial investment amount. Moreover, this element of the capitalization ratio applies only to the depreciable part of the assets.
The rate of return on capital is constructed using the cumulative construction method:
+ Risk-free rate of return +
+ Risk premiums +
+ Investments in real estate +
+ Premiums for low real estate liquidity +
+ Awards for investment management.
Risk-free rate of return - interest rate on highly liquid assets, i.e. This is a rate that reflects “the actual market opportunities for investing the funds of firms and individuals without any risk of non-return.” The yield on OFZ and VEB is often taken as the risk-free rate.
In the assessment process, it is necessary to take into account that nominal and real risk-free rates can be both ruble and foreign currency. When recalculating the nominal rate into the real one and vice versa, it is advisable to use the formula of the American economist and mathematician I. Fisher, which he derived back in the 30s of the 20th century:
; Where
Rн – nominal rate;
Rр – real rate;
Jinf – inflation index (annual inflation rate).
When calculating the foreign exchange risk-free rate, it is advisable to make an adjustment using the Fisher formula taking into account the dollar inflation index, and when determining the ruble risk-free rate - the ruble inflation index.
Converting the ruble rate of return to the dollar rate or vice versa can be done using the following formulas:
Dr, Dv - ruble or foreign currency income rate;
Kurs – rate of exchange rate, %.
Calculation of the various components of the risk premium:
premium for low liquidity. When calculating this component, the impossibility of immediate return of investments made in the property is taken into account, and it can be taken at the level of dollar inflation for the typical exposure time of objects similar to the one being valued on the market;
risk premium investments in real estate. In this case, the possibility of accidental loss of the consumer value of the object is taken into account, and the premium can be accepted in the amount of insurance contributions in insurance companies of the highest category of reliability;
premium for investment management. The riskier and more complex the investment, the more competent management it requires. It is advisable to calculate the premium for investment management taking into account the coefficient of underload and losses when collecting rental payments.
Linked investment method, or investment group technique.
If a property is purchased using equity and borrowed capital, the capitalization ratio must meet the return requirements for both parts of the investment. The value of the ratio is determined by the related investment method, or investment group technique.
The capitalization ratio for borrowed capital is called the mortgage constant and is calculated using the following formula:
Rm – mortgage constant;
DO – annual payments;
K – mortgage loan amount.
The mortgage constant is determined by the table of six functions of compound interest: it is equal to the sum of the interest rate and the compensation fund factor or equal to the contribution factor per unit of depreciation.
The capitalization rate for equity is called the mortgage constant and is calculated using the following formula:
Rc – equity capitalization ratio;
PTCF – annual cash flow before taxes;
Ks is the amount of equity capital.
The overall capitalization ratio is determined as a weighted average:
M – mortgage debt ratio.
If a change in the value of an asset is predicted, then it becomes necessary to take into account the return of the principal amount of capital (the recapitalization process) in the capitalization ratio. The rate of return on capital is called the recapitalization ratio in some sources. To return the initial investment, part of the net operating income is set aside in a recovery fund with an interest rate of R - the interest rate for recapitalization.
There are three ways reimbursement of invested capital:
straight-line return of capital (Ring method);
return of capital according to the replacement fund and the rate of return on investment (Inwood method). It is sometimes called the annuity method;
return of capital based on the compensation fund and risk-free interest rate (Hoskold method).
Ring method.
This method is appropriate to use when it is expected that the principal amount will be repaid in equal installments. The annual rate of return on capital is calculated by dividing 100% of the asset's value by its remaining useful life, i.e. It is the reciprocal of the asset's service life. The rate of return is the annual share of the initial capital placed in the interest-free compensation fund:
n – remaining economic life;
Ry – rate of return on investment.
Example.
Investment terms:
term - 5 years;
R
- rate of return on investment 12%;
the amount of capital invested in real estate is $10,000.
Solution. Ring's method. The annual straight-line rate of return on capital will be 20%, since in 5 years 100% of the asset will be written off (100: 5 = 20). In this case, the capitalization ratio will be 32% (12% + 20% = 32%).
Reimbursement of the principal amount of capital, taking into account the required rate of return on investment, is reflected in table. 3.4.
Table 3.4
Return of invested capital using the Ring method (USD)
|
Balance of investment at the beginning of the period |
Reimbursement of investment |
Return on invested capital (12%) |
Total income |
|
The return of capital occurs in equal parts over the entire life of the property.
Inwood method used if the capital return is reinvested at the rate of return on the investment. In this case, the rate of return as a component of the capitalization ratio is equal to the replacement fund factor at the same interest rate as for investments:
Where SFF- compensation fund factor;
Y=R(rate of return on investment).
Reimbursement of invested capital using this method is presented in table. 3.5.
Example.
Investment terms:
Duration - 5 years;
Return on investment - 12%.
Solution. The capitalization rate is calculated as the sum of the investment return rate of 0.12 and the compensation fund factor (for 12%, 5 years) of 0.1574097. The capitalization rate is 0.2774097, if taken from the column “Contribution for depreciation” (12%, 5 years).
Table 3.5
Recovery of invested capital using the Inwood method
|
Balance of principal amount at the beginning of the year, dollars. |
Total amount of compensation |
Including |
||
|
% on capital |
compensation principal amount |
|||
Hoskold method. Used when the rate of return on the initial investment is somewhat high, making reinvestment at the same rate unlikely. For reinvested funds, it is assumed that income will be received at a risk-free rate:
where Yb is the risk-free interest rate.
Example. The investment project provides for an annual 12% return on investment (capital) for 5 years. Return on investment amounts can be safely reinvested at a rate of 6%.
Solution. If the rate of return on capital is 0.1773964, which is the recovery factor for 6% over 5 years, then the capitalization rate is 0.2973964 (0.12 + 0.1773964).
If it is predicted that the investment will lose only part of its value, then the capitalization ratio is calculated slightly differently, since capital is repaid through the resale of real estate, and partly through current income.
Advantages the income capitalization method is that this method directly reflects market conditions, since when it is applied, usually a large number of real estate transactions are analyzed from the point of view of the relationship between income and value, and also when calculating capitalized income, a hypothetical income statement is drawn up, the basic principle of which is the assumption of the market level of real estate exploitation.
Flaws The income capitalization method is that:
its application is difficult when there is no information about market transactions;
The method is not recommended for use if the object is unfinished, has not reached the level of stable income, or has been seriously damaged as a result of force majeure and requires serious reconstruction.
3.5.3.2. Discounted Cash Flow Method
The discounted cash flow (DCF) method is more complex, detailed and allows you to evaluate an object in case of receiving unstable cash flows from it, modeling the characteristic features of their receipt. The DCF method is used when:
it is expected that future cash flows will differ significantly from current ones;
there is data to justify the size of future cash flows from real estate;
income and expense flows are seasonal;
the property being assessed is a large multifunctional commercial facility;
the property is under construction or has just been built and is being put into operation (or put into operation).
The DCF method estimates the value of real estate based on the present value of income, consisting of projected cash flows and residual value.
To calculate DCF, the following data is required:
duration of the forecast period;
forecast values of cash flows, including reversion;
discount rate.
Calculation algorithm for the DCF method.
1. Determination of the forecast period. In international assessment practice, the average forecast period is 5-10 years; for Russia, the typical value will be a period of 3-5 years. This is a realistic period for which a reasonable forecast can be made.
2. Forecasting cash flow values.
When valuing real estate using the DCF method, several types of income from the property are calculated:
1) potential gross income;
2) actual gross income;
3) net operating income;
4) cash flow before taxes;
5) cash flow after taxes.
In practice, Russian appraisers discount income instead of cash flows:
CHOD (indicating that the property is accepted as not burdened with debt obligations),
net cash flow less operating costs, land tax and reconstruction,
taxable income.
It is necessary to take into account that it is the cash flow that needs to be discounted, since:
cash flows are not as volatile as profits;
the concept of “cash flow” correlates the inflow and outflow of funds, taking into account such monetary items as “capital investments” and “debt obligations”, which are not included in the calculation of profit;
the profit indicator correlates income received in a certain period with expenses incurred in the same period, regardless of actual receipts or expenditures of funds;
cash flow is an indicator of the results achieved both for the owner himself and for external parties and counterparties - clients, creditors, suppliers, etc., since it reflects the constant availability of certain funds in the owner’s accounts.
Features of calculating cash flow when using the DCF method.
1. Property tax (real estate tax), consisting of land tax and property tax, must be deducted from actual gross income as part of operating expenses.
2. Economic and tax depreciation is not a real cash payment, so taking depreciation into account when forecasting income is unnecessary.
4. Loan servicing payments (interest payments and debt repayments) must be deducted from net operating income if the investment value of the property is assessed (for a specific investor). When assessing the market value of a property, it is not necessary to deduct loan servicing payments.
5. Business expenses of the property owner must be deducted from the actual gross income if they are directed
to maintain the necessary characteristics of the object.
Thus, dcash flow (CF) for real estate calculated as follows:
1. DV is equal to the amount of PV minus losses from vacancy and collection of rent and other income;
2. NAV is equal to DV minus OR and business expenses of the real estate owner related to real estate;
3. DP before taxes is equal to the amount of NPV minus capital investments and expenses for servicing the loan and loan growth.
4. DP is equal to DP before taxes minus payments for income tax of the property owner.
The next important stage is calculating the cost of reversion. The cost of reversion can be predicted using:
1) assigning a sales price based on an analysis of the current state of the market, monitoring the cost of similar objects and assumptions regarding the future state of the object;
2) making assumptions regarding changes in the value of real estate during the ownership period;
3) capitalization of income for the year following the year of the end of the forecast period, using an independently calculated capitalization rate.
Determining the discount rate.“A discount rate is a factor used to calculate the present value of a sum of money received or paid in the future.”
The discount rate should reflect the risk-return relationship, as well as the various types of risk inherent in the property (capitalization rate).
Since it is quite difficult to identify a non-inflationary component for real estate, it is more convenient for the appraiser to use a nominal discount rate, since in this case, forecasts of cash flows and changes in property value already include inflation expectations.
The results of calculating the present value of future cash flows in nominal and real terms are the same. Cash flows and the discount rate must correspond to each other and be calculated in the same way.
In Western practice, the following methods are used to calculate the discount rate:
1) cumulative construction method;
2) a method for comparing alternative investments;
3) isolation method;
4) monitoring method.
Cumulative construction method is based on the premise that the discount rate is a function of risk and is calculated as the sum of all risks inherent in each specific property.
Discount rate = Risk-free rate + Risk premium.
The risk premium is calculated by summing up the risk values inherent in a given property.
Selection method- the discount rate, as a compound interest rate, is calculated based on data on completed transactions with similar objects on the real estate market.
The usual algorithm for calculating the discount rate using the allocation method is as follows:
modeling for each analogue object over a certain period of time according to the scenario of the best and most effective use of income and expense streams;
calculation of the rate of return on investment for an object;
process the results obtained by any acceptable statistical or expert method in order to bring the characteristics of the analysis to the object being assessed.
Monitoring method is based on regular market monitoring, tracking the main economic indicators of real estate investment based on transaction data. Such information needs to be compiled across different market segments and published regularly. Such data serves as a guide for the appraiser and allows for a qualitative comparison of the obtained calculated indicators with the market average, checking the validity of various types of assumptions.
Calculation of the value of a property using the DCF method is carried out using the formula:
; Where
PV – current value;
Ci – cash flow of period t;
It is the discount rate for cash flow of period t;
M – residual value.
The residual value, or reversion value, must be discounted (by the factor of the last forecast year) and added to the sum of the present values of the cash flows.
Thus, the value of the property is = Present value of projected cash flows + Present value of residual value (reversion).
| Previous |
Actual gross revenue is potential gross revenue minus projected underutilization and collection losses.
To determine the actual gross income, adjustments were made for possible underutilization of space and the risk of shortfall in rent.
Taking into account the good technical condition of the assessment object, its fairly advantageous location in the city center, as well as the presence of other factors contributing to its normal operation, a constant load of the assessment object is predicted throughout the entire forecast period. According to an analysis of the real estate market, despite the constant increase in prices for properties in the central part of the city of Irkutsk, the occupancy rate of commercial premises is 95-100%. According to the data provided by the Customer, the occupancy of the assessed premises is ~100%. Taking into account the nature of the property being assessed, the structure of the premises being assessed, as well as taking into account the possibility of effectively managing the property being assessed and potentially maintaining the occupancy of its premises at the current high level, in this work the occupancy of the premises being assessed is assumed to be at an average level of 97.5%.
Current practice shows that cases of non-payment or long delays in rental payments occur in any market relationship. Taking into account the general economic situation in the country, the situation on the real estate market, the favorable location of the property being assessed in the city center, as well as data on the rental of similar non-residential real estate in various areas of Irkutsk, the amount of adjustment for the risk of shortfall in rent was adopted in the calculations equal to 5%.
The calculation of the actual gross income from the operation of the assessed property is given below in Table 8.7.
Operating expenses.
When calculating the market value of property using the direct capitalization method, the so-called magnitude net operating income, i.e. income from the operation of the property minus the landlord's expenses for its maintenance.
Net operating income is equal to the difference between actual gross income and operating expenses. In this case, only those operating expenses that, as a rule, are borne by the lessor are deducted from the actual gross income.
The amount of operating expenses is determined based on market conditions for leasing single real estate objects. Operating expenses are divided into: constant - independent of the occupancy level of a single property, variable - dependent on the occupancy level of a single property and costs for replacing elements of improvements with a useful life less than the period of use of the improvements as a whole (hereinafter referred to as elements with a short useful life ). Operating expenses do not include depreciation charges on real estate and expenses for servicing debt obligations on real estate.
The cost of replacing improvement elements with a short lifespan is calculated by dividing the amount of costs for creating these improvement elements by the period of their use. In the process of performing these calculations, it is advisable to take into account the possibility of a percentage increase in funds to replace elements with a short service life.
Management expenses are included in operating expenses regardless of who manages the property - the owner or the manager.
Based on the most typical market conditions for leasing commercial real estate, prevailing on the date of assessment in Irkutsk, the main part of operating expenses (including costs for electricity, utilities, maintenance of buildings and structures - current repairs, etc.) etc. costs, expenses for cleaning and security of the territory, other expenses directly related to the operation of real estate for commercial purposes), as a rule, are borne by the lessor; Accordingly, the above-mentioned expenses were taken into account when forecasting the costs of maintaining and operating the property being valued when assessing it using the income approach.
The forecast of costs for the maintenance and operation of the property being valued in this case is made taking into account the following assumptions and assumptions:
The amount of main operating costs for the subject of assessment was determined based on data on the amount of actual costs for 8 months of 2005, provided by the Customer. At the same time, we proceeded from the assumption that the amount of operating costs presented by the Customer corresponds to market conditions for the operation of similar real estate properties in the area under consideration.
Calculation of costs for replacing improvement elements with a short period of use is made by dividing the amount of costs for creating these improvement elements by the maximum period of their use (on average no more than 20 years), taking into account the percentage increase in funds for replacing elements with a short period of use (this is predicted , that the most reliable, accessible and typical for increasing funds in this case is a foreign currency deposit in one of the largest banks in the region).
The cost of replacing items with a short lifespan is calculated using the following formula:
RZ – costs of replacing elements with a short lifespan, rub./year;
SE– cost of reproduction (replacement) of elements with a short service life, rub. (rounded: 6,639,000 rubles; defined as the total replacement cost of the appraised object (10,059,000 rubles; p. 2.14 of Table 6.5), multiplied by the share of elements with a short period of use in the replacement cost of the appraised building, taking into account adjustments for the degree of implementation (66.00%%; total of column 6 of Table 6.6 for short-lived elements));
i – used capital return rate, % (6.8% is the average rate of return on long-term foreign currency deposits offered by the largest banks in Irkutsk, as of the beginning of September 2005);
n – the number of intervals until the cost of replacing the element is incurred (20 years).
The amount of land tax in this assessment is determined based on the tax base (the cadastral value of a land plot is determined for cadastral quarter 38:36:000034 (RUB 7,735.50/sq.m.; settlement lands for trade, public catering, consumer services) in in accordance with the Decree of the Governor of the Irkutsk Region dated February 28, 2003 No. 87-p “On the results of the state cadastral assessment of lands in settlements of the Irkutsk Region”) and the land tax rate (1.5%) in accordance with the Tax Code of the Russian Federation.
The amount of property tax is determined based on the weighted average value of the valuation object, obtained by cost and comparative approaches (see Section 9 of the Report) without taking into account VAT and the market value of the land plot (see paragraph 6.1 of the Report), as well as the property tax rate (2 .2%) in accordance with the Tax Code of the Russian Federation, Law of the Irkutsk Region dated November 26, 2003 No. 59-OZ “On the property tax of organizations, as well as on the recognition of certain laws of the Irkutsk Region as invalid.”
The forecast for the operating costs of the owner of the property being assessed is presented below in Table 8.7.
Gross income);
NOR (net operating income);
DP (cash receipts) after interest payments on the loan.
1.1. Potential Gross Income(PVD) - income that can be obtained from real estate with 100% use of it without taking into account all losses and expenses. PPV depends on the area of the property being assessed and the established rental rate and is calculated using the formula:
Lease contract- the main source of information about income-generating real estate. Lease is the provision of property to the lessee (tenant) for a fee for temporary possession and use. The right to lease property belongs to the owner of the property. Lessors can be persons authorized by law or the owner to rent out property. One of the main regulatory documents regulating rental relations is the Civil Code of the Russian Federation (Chapter 34).
In the process of work, the appraiser relies on the following provisions of the lease agreement:
Under a lease agreement for a building or structure, the tenant simultaneously with the transfer of rights of ownership and use of such real estate the rights to use that part of the land plot are transferred, which is occupied by this real estate and is necessary for its use, even in the case when the land plot on which the leased buildings or structures are located is sold to another person;
If the lease term is not specified in the agreement, then the lease agreement is considered to be concluded for an indefinite period;
The transfer of property for rent is not a basis for termination or cancellation of the rights of third parties to this property. When concluding a lease agreement, the lessor is obliged to warn the tenant about all the rights of third parties to the leased property (easement, right of lien, etc.). Otherwise, the tenant has the right to demand a reduction in rent or termination of the contract and compensation for losses.
Lease agreement for a building or structure:
Is concluded in writing for a period of at least one year, subject to state registration and is considered concluded from the moment of such registration;
Provides for the terms and amounts of rent agreed upon by the parties, without which the lease agreement is considered not concluded;
If the tenant has made at his own expense and improvements with the consent of the lessor leased property, inseparable without harm to the property, then it has the right, after termination of the contract, to be reimbursed for the cost of these improvements, unless otherwise provided in the lease agreement. The cost of inseparable improvements to the leased property made by the lessee without the consent of the lessor, non-refundable;
The tenant has the right rent out the leased property with the consent of the lessor sublease, provide leased property for free use, and also make it as a contribution to the authorized capital.
The rental rate is usually depends on location of the object, its physical condition, availability of communications, rental period, etc.
Rental rates are:
Contractual (defined by the lease agreement);
Market (typical for a given market segment in a given region).
Market rental rate represents the rate prevailing in the market for similar real estate, i.e. is the most likely rent that a typical landlord would agree to let and a typical tenant would agree to lease the property for, which is a hypothetical transaction. Market rent is used to value freehold ownership, where the property is essentially owned, operated and enjoyed by the owner himself (what would be the income stream if the property were rented out).
Contract rental rate used to evaluate the lessor's partial property rights. In this case, it is advisable for the appraiser to analyze lease agreements from the point of view of the terms of their conclusion.
All lease agreements are divided into three large groups:
With a fixed rental rate (used in conditions of economic stability);
With a variable rental rate (revision of rental rates during the term of the contract is carried out, as a rule, in conditions of inflation);
With an interest rate (when a percentage of the income received by the tenant as a result of the use of the leased property is added to the fixed amount of rental payments).
It is advisable to use the income capitalization method in case of concluding an agreement with a fixed rental rate, in other cases it is more correct to use the discounted cash flow method.
1.2. Actual Gross Income(DVD) is potential gross income minus losses from underutilization of space and when collecting rent with the addition of other income from the normal market use of the property:
DVD = PVD - (Losses + Underutilization) + Other income
Typically these losses are expressed as a percentage of potential gross income. Losses are calculated at a rate determined for the typical level of management in a given market, i.e. The market indicator is taken as a basis. But this is only possible if there is a significant information base on comparable objects.
In the absence of such, to determine the coefficient of underutilization (underutilization), the appraiser first of all analyzes retrospective and current information on the object being assessed, i.e. existing lease agreements by duration, the frequency of their re-conclusion, the size of the periods between the expiration of one lease agreement and the conclusion of the next (the period during which units of the property are vacant) and on this basis calculates underutilization ratio(KND) of the property:
K nd = ∑(D p *T)/N a
where D p is the share of real estate units for which contracts are renewed during the year;
T - the period during which the real estate unit is vacant;
N a - the number of rental periods per year.
Example: 1000 m2 leased.
During the year there are 365 days: in January 3 days 25 m2 were not rented out, in June 6 days 100 m2 and in November 10 days 50 m2.
25 / (1000 / 100%) = 2.5%, D p1 = 0.025, T 1 = 3 days
100 / (1000 / 100%) = 10.0%, D p2 = 0.1 T 2 = 6 days
50 / (1000 / 100%) = 5.0%, D p3 = 0.05 T 3 = 10 days
N a = 4 periods
Knd = (0.025 * 3 + 0.1 * 6 + 0.05 * 10) / 4 = 0.29
The determination of the underutilization coefficient is carried out on the basis of retrospective and current information; therefore, to calculate the estimated ADV, the obtained coefficient must be adjusted to take into account possible space utilization in the future, which depends on the following factors:
General economic situation;
Prospects for the development of the region;
Stages of the real estate market cycle;
The relationship between supply and demand in the assessed regional segment of the real estate market.
Coefficient of planned load (use) of the facility:
1 - 0,159 = 0,841
The appraiser makes an adjustment for losses when collecting payments, analyzing retrospective information on a specific object with subsequent forecasting of these dynamics for the future (depending on the development prospects of a specific segment of the real estate market in the region):
Based on historical and current information, the appraiser can calculate total rate of underutilization and losses in the collection of rental payments with subsequent adjustment to predict the actual gross income:
where K NDP is the coefficient of underutilization and losses when collecting rental payments;
P a - losses when collecting rent;
P nd - losses from underutilization of space;
PPV - potential gross income.
In addition to losses from underuse and when collecting rental payments, it is necessary to take into account Other income, which can be linked to the normal use of a given property for the purpose of servicing, in particular, tenants (for example, income from renting out a parking lot, warehouse, etc.), and are not included in the rent.
1.3. Net operating income(CHOD ) - actual gross income minus operating expenses (OR) for the year (excluding depreciation):
CHOD = DVD - OR
Operating expenses- these are expenses necessary to ensure the normal functioning of the property and the reproduction of actual gross income.
Operating expenses divide:
1. Conditionally permanent;
2. Conditional variables (operational);
3. Replacement costs or reserves.
To conditionally constant include expenses, the amount of which does not depend on the degree of operation:
Property tax;
Insurance premiums (payments for property insurance);
Salary of service personnel (if it is fixed regardless of the building load) plus taxes on it.
To conditional variables expenses include expenses, the amount of which depends on the degree of operational workload:
Object and level of services provided:
Utilities;
For ongoing repair work;
Salaries of service personnel;
Payroll taxes;
Security costs;
Management expenses (usually it is customary to determine the amount of management expenses as a percentage of actual gross income), etc.
Expenses not taken into account when assessing for tax purposes:
- economic and tax depreciation, which is considered in calculations by the income approach as compensation and is considered part of the capitalization rate, and not an operating expense;
- loan servicing is a financing expense, not an operating expense, i.e. financing should not have an impact on the value of real estate (the assessment assumes typical financing for a given type of real estate, and the influence of atypical financing should be excluded);
- income tax is also not an operating expense(this is a tax on personal income, which may depend on factors (form of ownership, composition of property rights, tax status of the owner) not related to the real estate being assessed);
- additional capital structures usually increase income, total cost or extend the economic life of the product. The costs associated with them cannot be classified as operating;
- business expenses of the property owner, which do not lead to an increase in income received from real estate, are also not operational.
Replacement costs include expenses for periodic replacement of wear-out improvements (roofing, flooring, sanitary equipment, electrical fittings). Funds are supposed to be reserved in an account (although most property owners don't actually do this). The replacement reserve is calculated by the appraiser taking into account the cost of depreciating assets, the length of their useful life, as well as interest accrued on the funds accumulated in the account. If you do not take into account the replacement reserve, then net operating income will be overpriced.
In cases where real estate is purchased with borrowed funds, the appraiser uses this level of income in his calculations as cash receipts before taxes.
Cash receipts before taxes equal to annual net operating income minus annual debt service costs, i.e. reflect the cash receipts that the owner of real estate receives annually from its operation.
Net operating income – English Net Operating Income, is calculated by subtracting all operating expenses from annual gross income, but does not deduct interest expenses, depreciation of tangible assets and amortization of intangible assets, as well as income tax liability. While this metric has limited value in a company's management of available resources, it can be useful in understanding the impact that operating expenses have on gross income that is generated from operating and non-operating activities. From this perspective, a metric such as net operating income can be a useful tool for identifying areas of activity that are not performing at optimal levels.
One of the most important factors for the successful operation of a company is the creation of a management model that allows it to generate the maximum possible amount of income, while keeping operating costs as low as necessary to sell high quality goods and/or services. An accurate calculation of the amount of net operating income that was generated over a specific period of time (for example, a quarter or a calendar year) allows you to determine whether a company is operating at the highest possible level of efficiency. If the effect of operating leverage ( English Degree of Operating Leverage, DOL) is not as high as it should be, management must take steps to evaluate each area of performance and determine how to improve efficiency and thereby reduce operating costs. As a result, the company will be able to generate a higher amount of net operating income to cover any non-operating expenses, such as interest on loans, equipment upgrades or financing expansion projects.
Changes in net operating income from one period to the next can often serve as a means of identifying an emerging trend that will affect a company's future performance. For example, if there is a significant decline in this ratio after operating expenses have been covered, and this trend continues for two or more reporting periods, the company's top managers need to examine the reasons for the decline. For example, they could be a seasonal drop in sales, a decrease in income from previously made investments, an increase in prices for raw materials, etc. Once the cause is identified, the company can take steps to overcome the situation and thus maintain a sound financial position for the company.
It should be noted that when calculating the amount of net operating income, some companies may resort to less than ethical accounting practices, the purpose of which is to distort the actual situation for certain purposes. For example, this may mean that accounting records are organized in a way that allows the amount of net operating income to be understated. The purpose of this manipulation is to minimize tax liabilities or mislead investors. The methods used for this are usually within the limits of current legislation, however, the ethical side of such practices can be very questionable.
To assess full ownership and tenant rights
Net operating income (NOI) is calculated as an income stream.
The use of NPV makes it possible not to take into account differences between different properties in the capital structure and payment of taxes, which makes the assessment of the value of different real estate more comparable.
Traditionally, when assessing real estate, the main source of income is considered to be the rental of the property being assessed. Renting an object, as a rule, manifests itself in two main forms:
Renting the property as a whole (building, land);
Renting part of an object (room, apartment, office in a business center, hotel room, parking space, garage in a cooperative, ward or bed in a commercial hospital, seats in a movie theater, etc.).
However, as practice shows, these two classical forms do not exhaust the entire variety of sources of income. Recently, a method of assessing an object has become widespread, in which the source of income is the income from the sale of the object in parts over a certain period of time (analogous to the classical method of developing a land plot). This method is often used to assess the value of a plot of land on which a building is being erected (for residential or non-residential purposes) with the subsequent sale of its individual parts to more than one buyer. There may be other sources of income. The main thing is that the source of income is direct
and is inextricably linked to the asset being valued, i.e. income must be a function of the asset being valued only. If a product or service is not related to the property being valued (for example, gasoline at a gas station), it cannot be considered a source of income when assessing real estate. In this case, it is necessary to talk about business valuation, including
includes, in addition to the value of real estate, the value of movable property and intangible assets. Income generated by the business located on the property includes
includes the income generated by the real estate itself and the assets inherent in the business. However, valuation theory does not exclude the possibility of valuing real estate from a business perspective. The most typical example is the assessment of a hotel complex. But in this case, it is necessary to correctly allocate the income attributable to real estate in the total business income.
and use it to evaluate the latter.
Net operating income in the most general case can be defined as the difference between actual gross income and operating expenses for the year.
CHOD = DVD - OR, (5.2)
where DVD is the actual gross income, den. units; OR - operating expenses, den. units
Operating expenses are expenses associated with the day-to-day operation of the property, necessary to ensure the normal functioning of the property and obtain the required level of actual gross income. (Fixed costs are expenses the value of which does not depend on the level of load of the facility (use of the asset). Variable costs are costs that vary depending on the load of the facility.)
Actual gross income is potential gross income minus losses from underutilization of space
and when collecting rent plus other income from the normal market use of the property:
DVD = PVD - Losses + Other income, (5.3)
where PPV is potential gross income, den. units
Losses are usually expressed as a percentage relative to
to potential gross income. The loss is based on the market indicator. Losses are caused by underutilization of the property, losses in collection of payments, etc.
Other income can be linked to the normal use of this property for the purpose of servicing tenants that are not included in the rent (income from renting out a parking lot, warehouse, etc.).
Potential gross income is the income that can be received from real estate if it is used 100% without taking into account all losses and expenses.
PVD = S C a, (5.4)
where PPV is potential gross income, den. units; S- rentable area, m2; WITH a - rental rate per 1 m 2, den. units/m2.
IPV is calculated based on the analysis of market data on the income of objects similar to the one being assessed, but it is mandatory
taking into account the analysis of contracts already concluded for the object being assessed. At the same time, taking into account existing lease agreements when assessing an object is mandatory if, in accordance with the contribution principle, the costs of terminating an unprofitable agreement are less than the economic benefits that will appear after this termination. The economic benefit, obviously, can be calculated as the current value of the difference between the market and contract rental rates after termination of the contract, multiplied by the area of the premises.
If termination of contracts is not economically feasible, then potential income in relation to vacant space is calculated at market rental rates, and for areas for which lease agreements have been concluded during the term of the contract - at negotiated (contract) rates. If the forecast period is longer than the lease term, then at the end of the lease agreement, the forecast of income from this area should be based on market rental rates.
The difficulty in accounting for existing leases is that the calculated net operating income must be converted into the value of the subject property using capitalization or discount rates derived from an analysis of market data for properties comparable to the subject not only in location and physical characteristics, but also by economic indicators: by level
and the share of contract lease in PVD.
Such an analysis can cause significant difficulties in the absence of market information. Sometimes they resort to such an assessment procedure when the calculation of the NPV is carried out on the basis of market rent, converts it into value, and subtracts the current value of the difference from the market one from the final result.
and contract leases calculated using market discount rates. The reliability of a particular approach is determined by the availability and completeness of market information about the objects used as analogues.
When assessing PVD, the structure of the rental payment, which depends on the type of lease, is quite important. In general, there are three types of leases: gross lease, net lease and absolutely net lease. A gross lease assumes that all operating expenses are borne by the property owner. With a net lease, all operating expenses, with the exception of costs associated with taxes, insurance, management and external repairs of the property, are borne by the lessee. And with an absolutely net lease, the tenant pays for everything, except for the costs associated with managing the property.
When forecasting any components of net operating income and possible trends in its change, the appraiser is obliged to adhere to a logic in his assumptions that would correspond to the thinking of a typical investor in the market of the property being valued.
