PAYMENTS IN ADVANCE (ANNUITIES DUE)
Rents are paid in advance that is, they are paid at the beginning of
the lease period and for each rent period after that.. For example, if
a building is leased at monthly periods, the lessee must pay the
landlord one month's rent on the first day of occupation and on the
monthly anniversary of that date until the end of the lease period.
Therefore, investors in real estate enjoy an advantage over other
investments such as bank deposits where the interest is paid at the end
of the period that is, "in arrears".
If the period is monthly or weekly and the interest rate is low, such
adjustments to the valuation equation are small enough to be ignored in
practice because errors in the rest of the valuation equation far
outweigh any error caused by not taking into account these two factors.
Further, if the capitalization rate has been correctly analyzed from
comparable sales and adjustment for that advantage is built into the
the other hand, if the rent is being paid quarterly, half yearly, or
yearly and interest rates are relatively high, then such an adjustment
should be made.
Another school of thought is that the adjustment should be made any
case because it is easily included in the valuation calculation
particularly when computer spreadsheets and financial calculators are
ADJUSTMENTS FOR ANNUITIES DUE
Financial calculators have an annuity
key for this calculation for example, the <2ndF>+<BGN/END>
keys on the Sharp EL 735. The advantage of an annuity due investment is
that the lessor can invest the rent payment for one period. Therefore,
the adjustment is to increase the nominal rent by the opportunity cost
of investment for one period.
Current rent: 1 000 per month
Interest rate: 1% per month
AA = AD * (1+i)
AA = annuity in arrears
AD = annuity in advance or annuity due
i = interest rate as a decimal.
AA = 1000 * 1.01 = 1010 per month.
Therefore, 1010 per month in arrears is equal to 1000 per month in
advance. All calculations and values can now be determined by using
1 010 instead of 1 000 per
Determine the market value of the above investment property at 8% per
MV = NAI * 100/CR
MV = 1010 * 100/(8/12) =
Note that a monthly capitalization rate is used instead of the annual
The capitalization rate analyzed from comparable sales can be
determined with annuities due instead of the more common method,
annuities in arrears as shown in the following example:
Sale price: 100 000
Net monthly rent: 1 000
Interest rate: 1% per
Adjusted capitalization rate:
CR = NAI/SP * 100
CR = capitalization rate
NAI = net annual income adjusted for annuities due
SP = sale price
CR = (1000 * 1.01)/100000 * 100 = 1.01% per month
= 12.12% per annum
What is the effective annual rate?
nominal and effective interest rates