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Unformatted text preview: Valuation of Income Properties and Investment Analysis
HKU Real Estate Finance K. S. Maurice Tse
School of Economics and Finance The University of Hong Kong email@example.com Content
Hedonic Pricing Approach Cost Approach Sales Comparison Approach Projected NOI Approach Real Estate Investment Performance Assignment I. Hedonic Pricing Model for Residential Real Estate Hedonic pricing model: Selling price (V) of a residential property is a function of its environmental variables such as locational factors (L), structural factors (S), and neighborhood factors (N) of the property. V = V (L,S,N) V is the property’s selling price as a function of L, S, and N.
Problem of hedonic pricing Does not indicate exactly what variables to incorporate into the estimation process. Does not indicate the exact functional form of the valuation process. ad hoc approach. Advantage of hedonic pricing Tell us how each of the different environmental factors may impact the market price of a property. Case Study on Hong Kong Island
As a case study, MCC (Mok, Chan and Cho) examined the pricing function for properties lying within a captured zone of 300-meter radius from every MTR exit between Central and Chai Wan on Hong Kong Island for the month of August 1990 only. They identified 1,027 transactions for the month of August 1990. Case Study Contd
MTR Map: Hong Kong Island 1990 Case Study Contd Properties lying within a captured zone of 300meter radius from every MTR exit between Central and Chai Wan on Hong Kong Island Locational Factors
Central, Admiralty, Wan Chai, and Causeway Bay are considered collectively the CBD. Distance from the CBD is measured by the distance between the property and the MTR exit at Causeway Bay. The higher the floor, the higher the market value of the flat. This variable is set equal to one whenever a flat has at least one window with a harbor view, zero otherwise. STORY SEAVIEW Structural Factors
This variable, the gross floor area, is used as a proxy for indicating the number of bedrooms, living room, dining room, and family room of a unit. AGE
This variable serves to capture the physical condition of a property. Neighborhood Factors
The school zone includes Tin Hau, Fortress Hill, North Point, and Causeway Bay. For property falling in this school zone, the variable is set equal to one, otherwise zero. BGESTAT SPORTF For properties belonging to an estate with 10 or more towers (Big Estate), the variable is set equal to one, zero otherwise. For estate with entertainment and/or sport facilities such as swimming pools, tennis/squash courts, sauna, or nearby clubs, the variable is set to one, zero otherwise. Multiple Regression analysis 回歸分析法 Hedonic Pricing Function
P iλ - 1 λ + β6 = β0 + β1 C BD iλ - 1 λ + β2 S T OR Y iλ - 1 λ + β8 + β3 S EAVIEW iλ - 1 λ + εi + β4 G FA iλ - 1 λ + β5 A GE iλ - 1 λ S CHOOL iλ - 1 λ B GES T AT iλ - 1 λ S POR T F iλ - 1 λ + β7 equation was estimated using λ = 1 for all variables λ = 0 for the dependent variable λ = 0.71 for the dependent variable and λ = 1 for all independent variables λ = 0 for the dependent and all continuous independent variables Pi is the transaction price for the ith unit and this Results
What do the results mean?? What is the pricing function like?? What does it mean?? Application
Price = 1823 – 29.5*DCBD + 7.066*Story + 106.82 * SEAVIEW – 0.0808 GFA – 20.115 AGE + 16.155 SCHOOL + 75.426 BGESTAT + 117.24 SPORTF What is the estimated market price of a flat with the following listed information?
Distance from CBD = 2 km Story = 25 Sea view = yes Gross floor area = 1,300 sf Age = 10 years School District = yes Big Estate = no Sport facilities = yes Estimated market price = $1,698 per square feet Comments
Robustness with respect to time. What about other parts of Hong Kong/other parts of the City? II. Cost Approach
Rationale for Cost Approach
An informed buyer of real estate would not pay more for a property than what it would cost to buy the land and build the structure. New Property:
Determine the construction cost of building a given improvement then adding the market value of land. II. Cost Approach Contd.
First estimate the cost of replacement. Reduce the cost by estimating physical deterioration functional or structural obsolescence due to the availability of more efficient layout designs and technological changes that reduce operating costs external obsolescence that may result from changes outside of the property such as excessive traffic, noise, or pollution. II. Cost Approach Contd.
Complications for income producing properties: structural design equipment variations locational influences. Most useful when the structure is relatively new and depreciation or obsolescence does not present serious complications. May be the only method available when there are very few sales and market data are scarce. Example Example: Estimate the value of a 15years old small office complex. Step 1: Collection of Information as if the office was new. Small Office Complex: 36,750 square feet; projected life 50 years Component Cost ($00) PSF ($00) Excavation-back fill $31,500 Foundation 47,250 Framing 160,500 Corrugated steel exterior walls 267,750 Brick Façade (front)-glass 51,000 Floor finishing, concrete 61,000 Floor covering offices 17,500 Roof trusses, covering 115,040 Interior finish offices 57,400 Lighting fixtures, electrical work 83,400 Plumbing 114,500 Heating-A/C 157,500 Interior cranes, scales 139,060 Loading docks, rail extension 96,000 Onsite parking 176,000 42.86 Subtotal 1,575,000 Architect, attorney, accounting $200,000 Construction interest 125,000 Builder profit 250,000 Subtotal 575,000 Land Cost (by comparison) Value per cost approach 350,000 2,500,000 68.00 Example: Estimate the value of a 15 years old small office complex Contd.
Step 2: Estimates of Depreciation and Obsolescence on Improved Property (15 years old)
• Replacement cost estimate (excluding land) • Repairable Interior finish Floor covering Lighting fixtures • Total • Nonrepairable 15 years divided by 50 years (age) • Function obsolescence • Layout design (inefficiency) Increasing operating cost (annually) • External obsolescence Loss in rent per year • Land Site value by comparison $2,150,000 25,500 5,200 17,000 47,700 30% 15,600 4,000 350,000 Example: Estimate the value of a 15 years old small office complex Contd.
Step 3: Adjustment of Replacement Cost Estimate
• Replacement cost at current prices Less: Repairable physical depreciation Subtotal • Nonrepairable physical depreciation, 30% • Function obsolescence $15,600 (35 years, 10%) • Economic locational obsolescence $4,000 (35 years, 10%) • Add: Site value • Value per cost approach 2,150,000 47,700 2,102,300 630,690 150,449 38,577 350,000 1,632,584 (or $1,630,000) ⎛ 1 − 1.1−35 ⎞ 150449 = 15600⎜ ⎜ 0.1 ⎟ ⎟ ⎝ ⎠ III. Sales Comparison Approach
Sales comparison approach is based on data provided from recent sales of properties that are highly comparable to the property being appraised. Rationale for Sales approach: Adjustments must be made to account for the differences between the property being appraised and recent sales of comparable properties in
Size Scale Location Age Quality of construction An informed investor would never pay more for a property than what other investors have recently paid for comparable properties. III. Sales Comparison Approach Contd
There are two ways to handle the adjustment. Adjustment 1:
Adjust the price per square foot paid for each comparable to determine the market value for the subject. The adjustments are made relative to the property being valued. Positive features that comparables possess relative to the subject property require negative adjustments and negative features require positive adjustments. Very subjective!! III. Sales Comparison Approach Contd
Adjust the relationship between gross rental income and sale prices on the comparable by developing the Gross Income Multipliers (GIM) for the comparable properties. Sale Pr ice GIM = Gross ⋅ Income
For subject property, gross income estimated based on the market data on comparables. For the comparable properties, the gross income should be annual income at the time the property is sold (what it will be during the first year for the purchaser). The gross income for the subject will be for the first year of operation after the date for which the property is being appraised. III. Sales Comparison Approach Contd
The GIM is based on prices before adjustment for the date of sale, location, and so on. These factors would affect both the gross income and the price of the property. When developing the GIM, some appraisers use Potential gross income (assume all the space is leased) or Effective gross income (potential gross income less vacancies). The results should be similar if the appraisers are consistent with their use of gross income measure. Example
Consider the following example on the development of the sales comparison approach for estimating the value of a small office with three comparable properties. Value is determined as of December 1991. Data Example Contd: Data
Market Area Analysis and Sales Data (Market Approach)
Item Sale Date Sale Price Gross Ann Rent Gross Square ft Percent leasable sf Price per sf Rent per sf Proximity to subject Frontage sf Parking spaces Number of floors Number of elevators Age Exterior Construction Landscaping Subject Property 1 Sep/91 $355,000 $58,000 14,500 91% $24.48 $4.00 2 miles 240 140 2 1 3 yrs Brick Average Average Comparable Properties 2 3 Jan/91 Dec/91 $375,000 $413,300 $61,000 $69,000 13,750 15,390 93% 86% $22.27 $26.86 $4.44 $4.48 2.5 miles 0.5 mile 310 350 130 155 2 2 1 1 4 yrs 2 yrs Stucco Brick Average Average Average Average 13,300 90% 300 130 2 1 New Brick Average Average Remark: The subject property is at the best location, and locations further away are less desirable. Example Contd: Adjustments from Comparables to Subject Property
Item Sale Price Gross Square ft Sale price per sf Adjustments Sale Date -Percent leasable sf -5% Location +7% Frontage +10% Age of Structure +8% Net Difference +20% Adjusted Price $426,000 Adjusted Price per sf $29.38 Estimated price per square foot for subject = $29.50 Indicated market value $29.50 * 13,300 sf = $392,350 Comparable Properties 1 2 3 $355,000 $375,000 $413,000 14,500 13,750 15,390 $24.48 $22.27 $26.86 +4% -10% +12% -8% +10% +8% $405,000 $29.45 -+5% +5% -10% +6% +10% $454,000 $29.54 Example Contd: Development of GIM (Comparable Properties)
Item Date of Sale Sale Price Current Gross Income GIM Comparable Properties 1 2 3 Sep/91 Jan/91 Dec/91 $355,000 $375,000 $413,300 $58,000 $61,000 $69,000 6.12X 6.15X 5.99X Rather than simply average the GIMs, the appraiser would normally give more or less weight to a particular comparable when choosing a rate to apply to the subject property. Appraiser may believe that the third comparable property should be given most weight because it was the most recent sale. Experience and the judgment of the appraiser is important Suppose the appraiser chooses a GIM of 6X for the subject property, then the appraised value of the subject property = $59,185 * 6 = $355,110. IV. Projected NOI Approach
Assumption: Real estate investors will pay a price reflecting the income potential of the property. It involves as a first step the development of the operating income statement. Data needed for estimating expected rents:
Surveys on comparable properties. Estimates must be made for normal vacancy and collection losses based on economic conditions expected to exist at the time of appraisal. NOI1 V= k−g Example
Consider the estimate of the value of the property by estimating the cash flows (NOI) over the 5-year holding period. The growth rate of NOI is 3% per year and the discount rate is 13%.
Year 1 2 3 4 5 Cash Flow $500,000 $515,000 $530,450 $546,364 $562,754 + 5,796,370 Value of the property based on projected NOI at year 6 Valuation of a Leased Fee Estate
Properties are often purchased subject to existing leases, and the terms in these leases must be honored by the investor. A leased fee estate is a property subject to such existing lease and such lease will affect the market value of the property. Upon the termination of the existing lease, the property can be leased out again at the current market rental rate. Example
A property is currently leased for $240,000 per year when market rents are $275,000 per year and are expected to increase by 2% per year. The property is expected to be sold at the end of year 10 based on a 10% capitalization rate. The current lease on the property will expire at the end of year 10 so the property can be leased in the 11th year at market rates. The appropriate capitalization rate for the leased fee estate is 12%. What is the market value of the leased fee estate? What is the market value of the property if there is no existing lease?
 The market value of the leased fee estate is $2.73 million. The market value of the property if there is no existing lease is $3.51 million. V. Real Estate Investment Performance
1. Real Estate Return
The market approach to measuring real estate return is called property yield. The property yield is defined as the ratio of annual rental income to property price: Annual ⋅ Re ntal ⋅ Income Pr operty ⋅ Yield = Pr operty ⋅ Pr ice
This ratio is similar to the dividend yields for stocks reported on the newspaper. Problem: Too Simple. But Easy to Use and Understand. 2. Constant Rental Income Growth Model
Assume that the rental income grows at a constant growth rate g for the indefinite future. Then the value of the property is given by the following familiar model. NOI1 V= k−g NOI1 k= +g V
Expected Property Yield for next period Price Appreciation Discussion
Many real estate agents would tell you, “You should buy the property now because the property yield is high and it is definitely a good investment.” How would you comment this statement?? What do past data say ??
Year 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 Hong Kong Property Yield (Annual Income/Property Price) Property Yield Rental Income Price Growth Growth 8.0 18.2 22.3 9.6 3.2 -13.5 10.3 -8.7 -14.8 10.4 -3.6 -4.4 9.8 5.6 11.6 9.7 8.8 10.4 8.6 9.6 22.6 8.3 16.2 21.6 8.3 26.6 26.5 8.2 10.0 11.0 6.4 8.2 37.8 4.9 9.3 41.8 Source: Property Review Discussion
What is the relationship between property yield and property price, short-term and long-term?? NOI1 V= k−g NOI1 k= +g V End of
Valuation of Income Properties ...
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- Spring '09