End of Chapter 15 Questions and Answers

End of Chapter 15 Questions and Answers - End of Chapter 15...

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End of Chapter 15 Questions and Answers 1. What is the traditional income approach to value? Answer: The traditional technique for commercial property is the income approach to value, which uses the simple formula: NOI Value = R R is the “capitalization rate” used to discount the Stabilized net operating income. NOI is the free and clear return on property prior to financing (as if no financing were used) 2. How can a perpetuity model result in a valid property value? Answer: NOI is considered as perpetuity although the properties do not have infinite lives. Properties have little value beyond 40 or 50 years, however the present value of those future returns is negligible and hence ignored. The model does not quantify a residual or reversion value, which balances the assumption of perpetual returns. 3. What is the difference between a discount rate and a hurdle rate? Answer: The discount rate and hurdle rate both are the “required rate of return” of the investor. Discount rates use the hurdle rate when the analysis is not capital constrained and all positive NPV deals can be accepted. When there are capital constraints and only the highest return deal can be accepted an IRR approach may be used. Both approaches might be used if there are some capital constraints and some capital rationing. 4. Why is a cap rate often lower then the expected and required rate of return? Answer: The cap rate reflects current returns on a non-levered basis. They do not include the appreciation return. With growth in rents and appreciation the actual total returns will be higher. 5. What is meant by the term “GIGO” in reference to the practical application of the DCF valuation procedure for commercial property? Answer: Garbage In Garbage Out. If the assumptions from market research are not realistic then the output of the proforma will also be unrealistic. 6. Describe some ways you can bias a value up or down? Answer: The following assumptions can over-value the property: Higher growth rate of rents than possible.
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Lower forecasts for capital improvements than reasonable. High resale price of property (i.e. very low going-out cap rate)
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End of Chapter 15 Questions and Answers - End of Chapter 15...

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