Lesson 16 Exercises – The Building Residual Techniques of Income Capitalization (The Income Approach to Value)

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  1. You are called upon to appraise a downtown commercial property. The owner claims that the property is over valued and that the taxes are too high. The following data is available concerning the subject property:
    1. A gross lease was signed three years ago for a term of ten years with a five-year option to renew. The rent, three percent of the gross sales, is stipulated in the lease contract, with a minimum of $1,500 guaranteed.
    2. A current market rent for the subject property is estimated at $2,250 per month.
    3. Vacancy and collection losses on comparable properties are approximately 2 percent of the annual gross income. A typical allowable expense ratio is 15 percent of the effective gross income.
    4. The building has a RCN of $180,000 and an estimated REL of 40 years. The land value is estimated at $75,000.
    5. The accounting records and financial statements of the owner reveal the following information concerning the subject property:
    Example of accounting records and financial statements of owner concerning subject property
    Income Category Year 1 Year 2 Year 3
    Annual Rental Income $18,000 $22,500 $24,000
    Expenses
    Insurance Premiums (three years) $2,655 $0 $0
    Rotary Club Dues $300 $300 $300
    Chamber of Commerce Dues $270 $285 $330
    Management $540 $675 $720
    Maintenance & Repairs $2,250 $180 $1,050
    Accountant (Audits) $1,050 $1,050 $1,050
    Interest on Mortgage $2,700 $2,550 $2,400
    Depreciation $4,200 $4,200 $4,200
    Real Estate Taxes $4,650 $4,743 $4,838
    Total Expenses $18,615 $13,983 $14,888
    Net Profit -$615 $8,517 $9,112
    1. Forecast the income and expenses for the current year. Process this data to Net Income imputable to land and improvements Before deducting for recapture and property Taxes [NIBT].
    2. Estimate the value of the property by the income approach to value. Use a 7 percent yield rate (straight-line declining terminal income premise) and 1 percent allowance for taxes.

  1. Potential Gross Income [PGI]: $2,250 × 12
    $27,000
    Vacancy & Collection Loss [V&CL]: $27,000 × 2%
    −
    $540
    Effective Gross Income [EffGI]
    =
    $26,460
    Operating Expenses: $26,460 × 15%
    −
    $3,969
    Net Income Before Recapture & Taxes [NIBT]
    =
    $22,491
  2. Net Income Before Recapture & Taxes [NIBT]
    $22,491
    Income Imputable to Land ($75,000 × .08)
    −
    $6,000
    Income Imputable to Building
    =
    $16,491
    $16,491 (Building Income) / 7% (Yo) + 1/40 (CRR) + 1% (ETR)
    = $157,057 (Building Value)
    Building Value:
    $157,057
    Land Value:
    +  75,000
    Total Value:
    $232,000±
  1. Assume the following data concerning the subject property:
    • Net Income Before deducting for recapture AND Taxes$62,520
    • Yield Rate7½%
    • Land Value$120,000
    • Terms of Lease33 years
    • Tax Allowance1%
    • Remaining Economic Life33 years

    Compute the value of the property using the level (constant) terminal income premise and the building residual technique.

Net Income Before Recapture & Taxes [NIBT]
$62,520
Income Imputable to Land [$120,000 × (7.5% Yo + 1% ETR)]
−
$10,200
Income Inputable to Building
$52,320
$52,320 (Building Income) / 0.092594 [7½% Yo + SFF{7½%,Ann,33yrs} + 1% ETR)
= $565,047
Indicated Building Value:
$565,047
Land Value:
+  120,000
Total Property Value:
$685,000±