Question

Name Real Estate Valuation Problems 1. If an investor has found a possible investment property with the net income after all operating expenses but before capital recapture from a small apartment house is estimated to be $48,000 per year: How much would an investor be willing to pay for the property if first mortgages are available for 75% the purchase price at 5.5% interest and the investor's equity capital investment requires a 15% return. The remaining life of the buildings is 50 years. Use the income approach to estimate the value of this property. a. What is the investor's weighted average cost of capital for the purchase of this investment property? b. What is the capitalization rate adjusted for recapture for this investor? c. What is the estimated value of this property using the income capitalization approach? d. What is the maximum price this investor can pay for this property and earn his or her required rate of return on investment capital?

Answer 1

The details provided in the question are:

1. Net operating Income before capital expenditure of the property is $48000

2. Mortgages available for 75% of the purchase price @ 5.5% interest

3. Investor's equity capital return requirement is 15%.

4. Remaining life of the building is 50 years.

Now lets solve the problems.

1. Investor's Weighted Average Cost of Capital (WACC)

WACC = (% Debt Financing * Cost of Debt) + (% of Equity Financing * Cost of Equity)

Putting the values from the given data we get

WACC = (75% * 5.5%) + (25% * 15%) = 7.875%

2. Capitalization rate for recapture for the investor

Capitalization rate = the rate of return the investor wants on a property; it consists of the return on the investment plus the recapture (through depreciation) of the investment

Capitalization rate = WACC + Recapture rate

Recapture rate : The recapture rate, also called the return of investment, measures the percentage of a property's value that you need to recover every year to break even over its economic life.

From the data given above we can calculate the recapture rate in 2 steps.

step 1

Divide 1 by the useful life of the investment to calculate the recapture rate as a decimal. i.e. 1/50= 0.02

step 2

Multiply the recapture rate as a decimal by 100 to figure the recapture rate as a percentage. i.e. 0.02*100= 2%

Now from the data above

Capitalization rate = 7.875%+2% = 9.875%

4. Maximum price the investor can pay for the property to earn his/her required rate of return on investment capital

Value= Net operating income / capitalization rate

By applying numbers from our calculations we get

Maximum price the investor can pay = $48000 / 9.875% = $ 486075.95

3.Estimated value of the property using income capitalization method

Value= Net operating income / capitalization rate

The Capitalization rate can vary from person to person and property to property. A Capitalization rate is the prevailing rate for similar property in similar neighborhood. If we assume the capitalization rate to be our investor's income capitalization rate the the value of the property will be:

Value of the property as per Income capitalization method = $48000 / 9.875% = $ 486075.95