Real Estate Valuation Insights

Subjective Real Estate Valuation G. JASON GODDARD

Chapter 5 Outline Chapter Highlights Divergent Expectations Seller Perceptions of Value Buyer Perceptions of Value Third Party Perceptions of Value Commercial Real Estate Brokers Commercial Real Estate Appraisers Commercial Real Estate Lenders

Seller Perceptions of Value # Units Unit Type Sq Ft Current Rent Monthly Income Pro-Forma Rents Monthly Income Apartment Rent Roll 28 2 Bed 1 Bath 828 $ 500 $ 14,000 $ 900 $ 25,200 Total 28 23,184 $ 500 $ 14,000 $ 900 $ 25,200 Apartment Rent Increases in an Improving Market

Seller Perceptions of Value Current 168,000 $ $ 168,000 $ $ 159,600 $ % Pro-Forma 302,400 $ $ 310,800 $ $ 301,728 $ % Gross Potential Rent Other Income Gross Potental Income Vacancy/Collection Effective Gross Income - 8,400 8,400 5.00% 9,072 3.00% Operating Expenses Real Estate Taxes Insurance General & Admin Repairs & Maintenance Water & Sanitation Gas & Electric Management Fee Replacement Reserves Total Op Ex Per Unit $ $ $ $ $ $ $ $ 3,731 $ Per Unit 888 $ 284 $ $ 800 $ 516 $ 908 $ 539 $ 250 $ 4,239 $ $ $ $ $ $ $ $ $ $ 24,870 7,952 888 284 - 600 516 908 285 250 $ $ $ $ $ $ $ $ $ 24,870 7,964 1,500 22,400 14,449 25,411 15,086 7,000 118,680 - 54 16,800 14,449 25,411 7,980 7,000 104,462 Net Operating Income Sales Price Implied Cap Rate Sales Price/GPI $ 55,138 2,600,000 $ $ $ 183,048 2,600,000 7.04% 2.12% 15.48 GRM 8.37 GRM Tale of Two Perspectives: Seller s Eyes

Seller Perceptions of Value NOI $55,138 $1,378,450 $1,102,760 $183,048 $4,576,200 $3,660,960 $3,050,800 $2,614,971 $2,288,100 4.00% 5.00% 6.00% 7.00% 8.00% $918,967 $787,686 $689,225 Range of Values as Cap Rates Change

Seller Perceptions of Value 0 1 2 3 4 5 6 183,048 Net Operating Income Annual Debt Service Reversionary CF Equity Cash Flow 125,322 $ $113,877 130,100 $ $113,877 116,783 $ $113,877 119,767 $ $113,877 108,118 $113,877 1,229,608 $ 1,223,849 $ 20.84% $ $ $ (500,000) $ 11,445 16,223 $ $ 2,906 $ 5,890 IRR Property Value Discount Rate 2,075,171 $ 9.00% Reversion Selling Costs (5%) Outstanding Loan Balance Equity from Reversion 2,600,114 $ 130,006 $ 1,240,500 $ 1,229,608 $ Seller s Calculation of Internal Rate of Return

Seller Perceptions of Value Period Equity CF 0 $ 1 $ 2 $ 3 $ 4 $ 5 $ PV of Equity CF (500,000) $ $ $ $ $ 795,418 $ $ (500,000) 11,445 16,223 2,906 5,890 1,223,849 10,500 13,655 2,244 4,173 42,782 NPV @ 9% Seller s Calculation of Net Present Value

Seller Perceptions of Value Not PV of CF PV of CF @ 9.00% IRR Partition Period 1 Period 2 Period 3 Period 4 Period 5 Total % of Total Operating CF $ $ $ $ $ $ 2% Reversion CF IRR Partition Operating CF Reversion CF Period 1 Period 2 Period 3 Period 4 1,229,608 $ Period 5 1,229,608 $ Total 98% % of Total 11,445 16,223 2,906 5,890 (5,759) 30,706 $ $ $ $ $ $ 10,500 13,655 2,244 4,173 (3,743) 26,829 3% $ $ 799,161 799,161 97% Seller s Partition of the Internal Rate of Return (IRR)

Buyer Perceptions of Value Net Operating Income Market Cap Rate Implied Price $ 55,138 7.00% 787,686 $ Buyer s Rebuttal # Units Unit Type 28 2 Bed 1 Bath 28 Sq Ft Current Rent Monthly Income Pro-Forma Rents Monthly Income 828 500 $ 14,000 $ 23,184 500 $ 14,000 $ Rent pfs 0.60 $ 0.60 $ Rent Roll Total $ $ $ 750 750 0.91 $ $ $ 21,000 21,000 0.91 Buyer s Projected Rent Increase

Buyer Perceptions of Value Current 168,000 $ $ 168,000 $ $ 159,600 $ % Pro-Forma 252,000 $ 14,000 $ 266,000 $ $ 258,440 $ % Gross Potential Rent Other Income Gross Potental Income Vacancy/Collection Effective Gross Income - 8,400 5.00% 7,560 3.00% Operating Expenses Real Estate Taxes Insurance General & Admin Repairs & Maintenance Water & Sanitation Gas & Electric Management Fee Replacement Reserves Total Op Ex Per Unit 888 $ 284 $ $ 600 $ 516 $ 908 $ 285 $ 250 $ 3,731 $ Per Unit 888 $ 284 $ $ 800 $ 516 $ 908 $ 539 $ 250 $ 4,239 $ $ $ $ $ $ $ $ $ 104,462 $ 24,870 7,952 24,870 7,964 1,500 22,400 14,449 25,411 15,086 7,000 118,680 $ $ $ $ $ $ $ $ $ - - 54 16,800 14,449 25,411 7,980 7,000 Net Operating Income Sales Price Implied Cap Rate Sales Price/GPI 55,138 2,600,000 $ $ 139,760 $ 1,996,571 $ 2.12% 15.48 7.00% 7.51 GRM GRM Tale of Two Perspectives: Buyer s Eyes

Buyer Perceptions of Value 0 1 55,138 $113,877 2 3 4 5 6 165,000 Net Operating Income Annual Debt Service Reversionary CF Equity Cash Flow $ 120,000 $ $113,877 130,000 $ $113,877 $ 140,000 $113,877 150,000 $113,877 1,267,500 $ 1,303,623 $ 20.05% $ $ $ (500,000) $ (58,739) $ 6,123 $ 16,123 $ 26,123 IRR Property Value Discount Rate 2,078,668 $ 9.00% Reversion Selling Costs (5%) 2,640,000 $ 132,000 $ 1,240,500 $ 1,267,500 $ Outstanding Loan Balance Equity from Reversion Buyer s Calculation of Internal Rate of Return

Buyer Perceptions of Value Period Equity CF (500,000) $ (58,739) $ $ $ $ 1,303,623 $ PV of Equity CF (500,000) $ (53,889) $ $ $ $ 847,266 $ $ 0 1 2 3 4 5 6,123 16,123 26,123 5,154 12,450 18,506 28,287 NPV @ 9% Buyer s Calculation of Net Present Value

Buyer Perceptions of Value Not PV of CF PV of CF @ 9.00% IRR Partition Period 1 Period 2 Period 3 Period 4 Period 5 Total % of Total Operating CF $ $ $ $ $ $ 2% Reversion CF IRR Partition Operating CF Reversion CF Period 1 (53,889) $ Period 2 $ Period 3 12,450 $ Period 4 18,506 $ Period 5 23,478 $ Total $ % of Total 1% (58,739) 6,123 16,123 26,123 36,123 25,754 5,154 1,267,500 $ 1,267,500 $ 98% $ $ 823,788 823,788 99% 5,699 Buyer s Partition of the Internal Rate of Return (IRR)

Third Party Perceptions of Value Commercial Real Estate Brokers Commercial Real Estate Appraisers Commercial Real Estate Lenders

Third Party Perceptions of Value Comparable Listings Subject Property Comparable #1 Comparable #2 Comparable #3 Comparable #4 Comparable #5 Rent psf Cap Rate 0.60 $ 1.02 $ 1.10 $ 0.70 $ 1.05 $ 0.88 $ Price/Unit 92,857 $ 116,389 $ 106,667 $ 93,000 $ 110,000 $ 93,548 $ 2.12% 6.15% 5.06% 8.06% 5.85% 7.00% Broker s Market Data

Third Party Perceptions of Value Rents per Square Foot Year 0 23,184 $ Year 1 0.60 $ Year 2 208,656 7,000 20,866 194,790 0.75 $ Year 3 0.85 $ Year 4 264,298 15,000 26,430 252,868 0.95 $ Year 5 278,208 16,000 27,821 266,387 1.00 $ Year 6 1.05 Reversion Gross Potential Income Other Income Vacancy Factor Efffective Gross Income 168,000 236,477 14,000 23,648 226,829 292,118 170,000 29,212 432,907 - 10.00% 8,400 159,600 Taxes Insurance Repairs & Maintenance Management Utilities Other Replacement Reserves Total Expenses 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% 10.00% 24,870 7,952 16,800 7,980 39,860 26,114 8,350 17,640 8,379 41,853 3,000 7,700 113,035 27,419 8,767 18,522 8,798 43,946 3,150 8,470 119,072 28,790 9,205 19,448 9,238 46,143 3,308 9,317 125,449 30,230 9,666 20,421 9,700 48,450 3,473 10,249 132,187 31,741 9,956 21,033 9,991 49,904 3,577 11,274 137,475 - 7,000 104,462 Net Operating Income 55,138 81,755 107,757 127,419 134,200 3,216,923 295,432 Annual Debt Service Tenant Improvements Leasing Commissions 113,877 113,877 113,877 113,877 113,877 - - - - - - - - - - Debt Coverage Ratio Net Cash Flows BTIRR On Equity 0.48 0.72 0.95 1.12 1.18 (500,000) 28.82% (58,739) (32,122) (6,120) 13,542 1,996,746 Property Value 2,370,000.00 $ Appraiser s Compromise

Third Party Perceptions of Value NOI 55,138 183,048 Cap Rate 6.50% 6.50% Value 848,277 $ 2,816,123 $ 2,370,000 $ 2,011,467 $ Current Pro-Forma DCF Average $ $ Appraiser s Value Conclusion

Chapter 5 Questions Questions for Discussion Elaborate on how divergent expectations of market participants are good and bad for economic growth. Explain how the interests of the real estate property broker and seller are often aligned. Explain how the interests of the real estate property lender and buyer are often aligned. Provide examples of situations when the interests of the real estate broker and lender are aligned. Provide examples of situations when the interests of the real estate broker and lender are in opposition.

Chapter 5 Questions Questions for Discussion Describe situations where the interests of the real estate broker and the seller are in opposition. Describe situations where the interests of the real estate lender and the buyer are in opposition. How might government intervention in markets affect the market participants involved in the sale of a real estate property? Discuss how an appraiser can help bridge the valuation gap between the eyes of the buyer and the eyes of the seller of a real estate property. Discus how a lender can help bridge the valuation gap between the eyes of the buyer and the eyes of the seller of a real estate property.

Chapter 5 Market Vignette Questions for Discussion Describe how the subjectivity of value might impact the viability of this investment alternative. Does this seem like a good investment option? Discuss the pros and cons and take a clear position. Does the idea of focusing on single family homes in this space versus larger apartment complexes make sense? Discuss the pros and cons and take a clear position. Elaborate on the risk and probability of government funding in this asset class going away. How might the loss of subsidies impact the risk profile of this property type? How easy or difficult would it be to remove a property from the government subsidy program in an effort to increase rents and change the tenant profile for the property that was the primary focus of this chapter?