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Basic Real Estate Valuation
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| Saturday, December 27, 2008 |
Given the current interest (dare I say hysteria) related to investment in the dirt and buildings, I thought it might be interesting for our readers to have a quick, dirty manual on 'property valuation. My perspective is for years in the industry as well as some time learning the knee of some of the best real estate minds in academia.
I separated (to some extent) to invest in his residence, consumption, invest in real estate for fun and profit. The reason for this separation is that many of the usefulness or value of his house is locked in the pleasure it was to live in it, or eat. Although there are some ego strokes to own large buildings, a building complex - if you want the value associated with the land, apartments, office buildings and warehouses is locked in the cash flow they provide or provide. [This building complex just to play with big trophy assets - I do not expect our readers to buy the Transamerica Pyramid or the Sears Tower, but there is an interesting argument why these buildings should be on their premiums nearby competitors - that the debate should take place at another time.]
The first principle is to understand that any asset is valuable only insofar as it will provide cash flow to its owner. It is important to see office buildings, and not as office buildings, but the rent creation machines. We must see the earth, not as dirt, but as an option to build and lease or sell - and therefore, create cash flow.
"But, JS, how can I decide what to pay for those cash flows?" And "JS, and cash flows are unpredictable and are difficult to estimate? I heard your questions, and they are good. And that is why there are different ways to assess the value of real assets .
There are four basic ways to bring the value of a building or a piece of land. It is the Discounted Cash Flow method, or DCF, there is the Cap rate method is the method of replacement costs and there is the comparable method. Each has its advantages and disadvantages.
DCF
Discounted Cash Flow or DCF analyze analyze is not unique to real estate, in fact, it works with most capital assets. DCF is the process of forecasting cash flows forward for some realistic period of time (investment banking analyst have done 10 years DCFS that he or she will see them in their sleep) usually five or ten years, then discount those cash flows back to the present to find the present value of the building. I do not get the ins and outs of the choice of discount rate (but perhaps one of my colleagues are columnists), but suffice it to say that the discount rate should take into account the relative importance of security of future cash flows (or more precisely, the risks associated with cash flows specific to the asset). Cash flows include rents or money to be spit and the terminal value (or value that the building will seek to sell (less transaction costs) at the end of Analysis). Here is an example of a DCF analysis. Notice how it could evaluate the building very differently depending on its discount rate. Suppose that the price for construction is $ 150 - perhaps it would not be such an investment. Build a simple model on Excel and violin with rent and parking flows show how these values analyzes are sensitive to even small changes.
The advantages of this type of evaluation is that if you are relatively safe for the future cash flows and to understand the true cost of your capital and the discount rate for this type of asset, you can get a good idea of what to offer or what you would be willing to pay for a property. Of course, the disadvantages are that, if anyone can accurately predict anything for the next ten years, I want to meet and buy anything they want - they deserve to be my weight or (no small number, I assure you). Also, the choice discount rate is an art not a science, as such, it is not only difficult, but it is also likely to be tinkered with. Or in other words, many of my colleagues (and JS is not to be held as better than anyone else) and myself have worked upstream to get the asking price. Or we did the model chosen and the discount rate to arrive at a value that will actually do construction.
In general, I do not support this type of evaluation. It is too sensitive to stop / errors and does not take into account the vagaries of the market. In addition, this method does not work well with the land, buildings vacant, the potential for redevelopment or any type of property that has no cash flow or extremely difficult to predict cash flow.
Ceilings
The method of securities or ceiling rate approach is similar to the DCF method. In fact, it is simply a shortcut to the DCF method. The following equation explains what ceiling is:
First year of construction ÷ NOI purchase price ceiling =
INO is the net operating income. NOI is essentially cash flow of a building, excluding debt service and income taxes (not taxes). For example, if we take the building above the DCF Analyze and we assume a purchase price of $ 100 and $ 10 NOI, the ceiling is 10%. [$ 10 / $ 100 = .10 or 10%]. To use a ceiling to find out what to pay for a building, just to understand two things, the NOI for the year after the purchase and the ceiling rate for similar assets (and it usually means tenants) in the market. If you deconstruct this method, it starts to look like a DCF valuation - but these similarities and why May or May not make sense is better saved for a later column.
INO is the net operating income. NOI is essentially cash flow of a building, excluding debt service and income taxes (not taxes). For example, if we take the building above the DCF Analyze and we assume a purchase price of $ 100 and $ 10 NOI, the ceiling is 10%. [$ 10 / $ 100 = .10 or 10%]. To use a ceiling to find out what to pay for a building, just to understand two things, the NOI for the year after the purchase and the ceiling rate for similar assets (and it usually means tenants) in the market. If you deconstruct this method, it starts to look like a DCF valuation - but these similarities and why May or May not make sense is better saved for a later column. In commercial real estate is the most common include housing prices or to discuss the evaluation. Brokers talk of commercial buildings from 8 to cap ". This means that a property sold at 12.5x its first year NOI. Be careful to delineate between" in-place NOI "and" projections "or" pro-forma NOI " . Also be prudent to accurately predict the capital necessary to maintain a building lease or rental measure. Because the rate cap only take into account NOI, they often do not distinguish between buildings that require massive amounts of capital and labor to maintain and those who do not.
In general, this is a great short cut to decide whether a building is useful to do more work. Analyze cap rate is just a starting point to decide what to bid for a property. But understanding the market rate ceiling (or the average rate ceiling that the assets were for the negotiation) is a very valuable indicator. I put that second best method of assessing property.
Replacement cost analyze
The replacement cost is analyze exactly what he seems. The replacement cost is the cost to recreate true that although the exact location. A good alternative to analyze costs not only take into account the value of land and construction costs but also developer profit and implementation cost of construction debt.
While brokers often say "It will trade below replacement costs, it is often not the case and also, this is not a metric. The replacement cost is a search back and a metric that does not include the most important thing, that the building will be able to win now. Remember, cash is king.
I say that, in general, this method is useless. The argument that if you buy something under replacement cost, you can only get hurt if nobody ever built here again is a miserable one. If you buy in a dynamic market with high volatility This argument may have some merit. But unless you receive an off-market deal or if there is reason to believe that other informed buyers have not been made aware of the operation you are a student , You should ask yourself why you can buy something at below replacement cost.
Comparable Analysis
This is the most important method of evaluation of any type of property, but it is particularly useful in real estate. The method comparable or accounting method is simply looking for assets in the market that are similar to those you are acquiring and watch what they have negotiated for a square meter, per acre or per unit basis. If you pay more, everybody on the market, there had better be a good reason. And if you pay less, understand why.
This method is best for "hard to value" free as buildings, land and homes. For these items, cash flows are non-existent or too difficult to estimate. Embedded in this method of assessment is a central theme, that of market efficiency. As long as there are enough bidders and relatively fair market prices at which assets have been trading are probably the best indication of their value.
If you have more specific questions about another method or something in this article, please do not hesitate to contact me or mail to http://www.whatbubble.com.
JS Silver is a real estate investor and co-editor whatbubble.com. If you want to publish your own comment, or have any financial questions answered by an expert for free or if you simply want to learn more about this topic please visit http://www.whatbubble.com. If you want to re-publish this article, please keep all the links. |
posted by neptunus @ 5:27 PM
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