Real Estate Valuation

■ Market value is a property’s actual worth –

the price at which a property would sell under
current market conditions
■ Different from stock or bond valuation:
❑ Each property is unique
❑ Terms and conditions of sale may vary widely
❑ Market information is imperfect
❑ Properties may need substantial time for market
exposure
❑ Buyers sometimes need to act quickly
Real Estate Valuation

■ Approaches to valuation
❑ Cost approach
❑ Comparative sales approach
❑ Income approach
Real Estate Valuation

■ Cost approach
❑ Based on the idea that an investor should not pay
more for a property than it would cost to rebuild it
at today’s prices for land, labor and construction
materials.
❑ A good method to use as a check against a price
estimate, but should not be used exclusively.
Real Estate Valuation

■ Comparative sales approach

❑ Basic input is the sales price of properties similar
to the subject property.
❑ Based on the idea that the value of a given
property is about is about the same as the prices
for which other similar properties have recently
sold.
Real Estate Valuation

■ Income approach
❑ Value is the present value of all property’s future
income.

Market Value = Annual net operating income/Market

capitalization rate
Real Estate Valuation

■ Annual net operating income (NOI) = Gross

potential rental income – vacancy and
collection losses, property operating
expenses

■ Market capitalization rate = rate of return

requirement
Real Estate Valuation

■ Investment Analysis
❑ Differs from market valuation in 4 ways:
■ Retrospective vs prospective
■ Impersonal vs personal
■ Unleveraged vs leveraged
■ Net operating income vs after-tax cash flows
Real Estate Valuation
■ Effect of positive leverage

No leverage 80% debt

Initial equity $20,000 $4,000
Loan principal 0 16,000
Sale price 30,000 30,000
Capital gain 10,000 10,000
Interest cost 0 1,920
Net return 10,000 8,080
ROE 10,000/20,000 = 8,080/4000 =
50% 202%
Real Estate Valuation

■ NOI vs after-tax cash flows

❑ In Investment Analysis, we use after-tax cash
flows instead of NOI.
❑ After-tax cash flows are the annual cash flows net
of all expenses
❑ Find net present value using the discounted cash
flow method.