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.