REVERSIONARY
CAPITALIZATION RATE (RCR)
The
reversionary method of valuation shows that the reversionary interest
assumes that the expected income will be the expected market rents
capitalized at the reversionary capitalization rate. This rate is one
of the most important statistics in the valuation of investment
properties as it measures the market's confidence and assessment in
the property in the long run.
Sales
of investment properties should be analyzed for the RCR. This is done
by using the reversionary method formula below. If the RCR falls, it
indicates that the market has greater confidence in the investment
potential of comparable properties in the future. The risk to
expected rental returns is safer and vice versa. This underlines the
important valuation principle that the capitalisation rates used in
the valuation of investment properties are determined by the market's
opinion of the future.
EXAMPLE
ANALYZING FOR THE RCR
Sale
price: $1 000 000
Current
net income: $50 000 pa
Residue
term of lease: 3 years
Market
or imputed rent or reversionary net income: $80 000 pa
• STEP
1:
Determine
the value of the lease:
For
short term periods (eg 3-5 years), state government bond rates plus
2-3% for the extra risk of real estate can be used.
State
government bonds @ 8% + 3% = 11 % pa
PVPMT
= (1 111.113)/0.11 = 2.444
LEEI = 2.444 * (80
000-50 000) = $73 320
STEP
2:
Determine
the lessor's interest:
LORI
= $1000 000 - 73 320 = $926 680
Less
PV of lease rent:
$50
000 * 2.444 = (122200)
Reversionary
value = $804 480
REVERSIONARY
CAPITALIZATION RATE
The
Reversionary Capitalization Rate (RCR) is derived from the following
formula:
Reversionary
value = PV(11%) * (market rent * 100/RCR)
804
480 = 0.7312 * (80 000 * 100/RCR) RCR = 7.271
The
reversionary capitalization rate of 7.27% pa is a measure of investor
confidence or measure of risk of the subject investment property in
the future.