**INVESTMENT
PROPERTIES**

**An
investment property is a property bought for future income and
benefits such as capital gain. For example, a block of flats.
Economic investment criteria is used to value such property. **

**VALUATIONS
FOR INVESTMENT PURPOSES**

**This
valuation standard consists of 6 elements:**

**investment
valuation applications.**
**complex
investment valuation applications**
**non routine
analysis methods.**
**client type**
**type of
property being valued.**
**report content.**

**DETERMINE
VALUATION OF INVESTMENT PROPERTIES**

**The
elements under the national standard are:**

**interpret
outcomes of analysis.**
**analyse data on
subject investment property.**
**determine
investment value.**
**record value,
analytical approaches used and qualifications required.**

**If
***utility* is the major component of value, the property is an
investment property and should be valued with the capitalization
method. Investment properties are properties bought by real estate
investors for expected future income and benefits (capital gains).
Examples of investment properties include hotels, motels, shopping
centres, office blocks, industrial warehouses and residential flats.

**See
utility diagram**

**THE
CAPITALIZATION RATE (CR)**

**The
market value of an investment property is the present value of all
future income and benefits from day 0 (date of valuation) into
perpetuity. This is shown on the following time line:**

**TIME
LINE DIAGRAM**

**The
time line is taken into perpetuity because the basis of ownership is
freehold which allows the owner to enjoy all rights of the land in
perpetuity. Even Canberra's leasehold system can be considered "quasi
freehold" based on the long term of the original lease and the
almost certain lease rollover at the end of the current lease period.**

**ANALYZING
THE CAPITALIZATION RATE**

**The
basic measure of rate of return on property is the ***initial yield*
or capitalization rate. This is simply the ratio of the initial or
starting net rent to the sale price expressed as a percentage:

**CR
= NAI/SP*100**

**Where:**

**CR
= the capitalization rate as a %**

**NAI
= net annual income**

**SP
= sale price**

**EXAMPLE**

**Sale
price: $1 000 000**

**Net
annual income: $110 000**

**CR
= 110000/1000000 * 100 = 11 or 11 % per annum**

**Because
11%pa is determined using the CURRENT net annual income of the
property, this method is known as the ***initial yield rate of
return*. The higher the capitalization rate, the higher the risk
of investment. For example, investment properties on the outskirts of
the CBD are riskier investments than those near the centre.
Therefore, potential buyers of such properties require a higher rate
of return as compensation for the extra risk.

**If
the above sale meets the criteria of the ***willing seller willing
buyer theory*, the initial yield can be used to value comparable
investment properties. Market value is determined with the following
formula:

**MV = NAI * 100/CR **

**Where:**

**MV
= market value**

**NAI
=net annual income**

**CR=
capitalization rate as a %**

**EXAMPLE**

**Net
annual income:$200 000**

**Capitalization
rate:11%pa**

**MV
= $200 000 * 100/11 = $1 818 200 say $1 820 000**

**YEARS
PURCHASE (YP) THE MULTIPLIER**

**The
factor used to multiply the net annual income in the capitalization
method (100/CR) is called the ***years purchase* or *multiplier*.
The name is derived from a commercial method for the valuation of
businesses using the "payback period". However, the real
estate industry prefers the initial yield capitalization rate (CR)
and it has become a universal measure of the investment return on
property. The years purchase is found with the following formula:

**YP
=100/CR**

**Where:**

**YP
= years purchase**

**CR
= capitalization rate as a %**

**The
years purchase for the above property is as follows:**

**YP
= 100/CR = 100/11 = 9.09 years.**

**NET
INCOME**

**The
periodic income from real estate can be expressed as either ***gross*
or *net* income. Net income is the gross income less all
relevant outgoings associated with the "day to day" running
of the subject property, that is, capital and unusual costs are
excluded. The “day to day” running costs are also known as the
*operating costs*. The net Income is the better measure of
return than gross income because it takes into account all those
outgoings that may be specific and peculiar to the subject property.

**EXAMPLE**

**Compare
the following two properties:**

**PROPERTY
A:**

**Gross
annual income (GAI) = $200 000**

**PROPERTY
B: **

**Gross
annual income (GAI) = $200 000**

**If
a 15% GROSS capitalization rate (analyzed from sales of comparable
properties) is used, the calculated market value of each property is
identical:**

**MV
= $200000 * 100/15 = $1 333 300**

**However,
after further investigation it is found that property B has higher
outgoings than property A because of higher property taxes and
insurances (it is located within a ***primary fire zone)*. The net
annual incomes are:

**PROPERTY
A: $120 000**

**PROPERTY
B: $100 000**

**By
analyzing comparable sales it is found that the appropriate NET
capitalization rate is 9% per annum. The resultant market values are:**

**PROPERTY
A: $120 000 * 100/9 = $1 333 300**

**PROPERTY
B: $100 000 * 100/9 = $1 111 100**

**Therefore,
by using the net annual income and thus accounting for the specific
costs relating to property B, a difference of $222 200 in value has
been accounted for. **

**Note
that the net capitalization rate is lower than the gross
capitalization rate for the same property. Therefore, a
capitalization rate should always be quoted as either net or gross so
as to avoid confusion. Generally, if a capitalization rate only is
quoted, it is assumed to be a net rate.**

**VARIATIONS
TO THE CAPITALIZATION METHOD**

**The
following are the main variations to the capitalization method:**

**adjustment for
rents paid in advance**
**use of a
monthly capitalisation rate with monthly income**
**"reversionary
method"**
**"shortfall
method".**

**See
investment properties – physical environment**
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