4. NORMATIVA PENAL EN MATERIA DE SEGURIDAD VIAL
4.4. Regulación penal actual de la Seguridad Vial Código Penal L.O 10/1995
4.4.3. Ley Orgánica 5/2010, de 22 de junio, por la que se modifica la Ley Orgánica
As we learned in the previous chapter both investors and lenders seek return on and return of their invested capital. We also learned that an overall capitalization rate contains a blend of return on and return of components and that the rates can fluctuate based on investment risk and recapture provisions.
Capitalization rates are derived from market data. As we will learn in this section, capitalization rates can be derived by several methods. These include market extraction method, mortgage equity band of investment method, debt coverage ratio method and the EGIM/OER Method
Market Extraction Method
The purest form of determining an overall capitalization rate is by market extraction (also known as abstraction). This is simply the IRV formula at work and is the preferred method for developing overall rates.
extraction - A method of deriving capitalization rates from property sales when
sale price and net operating income are known.
Market extraction of overall rates involves dividing the net operating income of the sale property by the sale price.
NOI $165,000 = .0971 or 9.71%
Sale Price $1,700,000
Example: Overall Rate Extraction 14-1
An apartment complex has effective gross income of $214,000 and expenses of $58,200. The property sold for $1,200,000. Calculate the overall capitalization rate.
Effective Gross Income $214,000
Operating Expenses - 58,200
Net Income $155,800
Using the IRV formula, we can now extract the overall capitalization rate from this property.
NOI $155,800 = .1298 or 13%
Sale Price $1,200,000
Similarity between the sale properties and the subject is important. Just as the inclusion or exclusion of replacement allowances can influence overall rates, so does the comparability of land-to-building ratios and remaining economic lives. Land-to-building ratios should be consistent as shown in the following illustration.
Sale 1
Sale 2
Land-To-Building Ratio
($) 1:2 Ratio
1:4 Ratio
Sale Price
$500,000
$500,000
Land Value
$166,667
$100,000
Building Value
$333,333
$400,000
Discount Rate
.0650
.0650
Recapture Rate
.0400
.0400
(25 Year Life-Straight Line)
NOI Required for Discount
$32,500
$32,500
NOI Required for Recapture
$13,333
$16,000
Total NOI
$45,833
$48,500
Overall Rate
.0917
.0970
As the above table indicates, as the ratio of building value to total property value increases, more net operating income is required to satisfy the recapture provision thus increasing the overall capitalization rate.
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The recapture provision is also impacted by the remaining economic life of the improvements. As the remaining economic life decreases, the recapture rate provision is increased which increases the overall rate. Conversely, as remaining economic life increases, the recapture rate is decreased thereby decreasing the overall rate.
The following example illustrates this relationship.
Remaining Economic Life
20 25 30
(Years) 40
Annual Recapture Rate 5.00% 4.00% 3.33% 2.50%
Discount Rate 8.00% 8.00% 8.00% 8.00%
Building Capitalization Rate 13.00% 12.00% 11.33% 10.50%
Land Capitalization Rate 8.00% 8.00% 8.00% 8.00%
Weighted Building Rate of Overall Rate (80%)
10.40% 9.60% 9.06%
8.40%
Weighted Land Rate of Overall Rate 1.60% 1.60% 1.60% 1.60%
(20%)*
Total Overall Rate 12.00% 11.20% 10.66% 10.00%
Improvement value equals 80% of total property value with the land value comprising the remaining 20%. While the land capitalization rate remains constant at 8% the building capitalization rates decrease as the remaining economic life increases. This is due to the lowering of the recapture provision.
Band of Investment Mortgage Equity Method
Most real estate investments are purchased through a combination of debt and equity. Each of these components must achieve a market based return. The mortgage lender needs to receive a competitive interest rate or return on their investment. Similarly, the borrower is also anticipating a competitive return on the equity invested and both seek return of their investment. When market information is available for the required returns on both debt and equity, it is possible to develop a capitalization rate. This rate is the
composite average of the weighted proportions of debt and equity. This method of developing a capitalization rate is called the band of investment technique.
band of investment - A technique in which the capitalization rates attributable to
components of a capital investment are weighted and combined to derive a weighted-average rate attributable to the total investment.
To use this technique it is necessary to gather information on available mortgage interest rates and terms, loan-to-value ratios and equity dividend rates. The formula for the band of investment is:
Loan Value % (M) x Mortgage Constant (RM)
+ Equity Value % (1-M) x Equity Dividend Rate (RE) Total Value (100%) Overall Rate
The components needed to perform the band of investment technique are summarized in the table below. Notice the heading of the box is IRV.
The following example will derive an overall capitalization rate by the mortgage equity band of investment technique.
Mortgage funds are available for 70% of the property's value and current mortgage interest rates are 7.00% amortized over 25 years with monthly payments of principal and interest. Based on these mortgage terms the mortgage constant (amount of annual debt service payments for each dollar borrowed) is .084814. Again, this represents the
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partial payment factor for the loan annualized. Typical investors require a 9% equity dividend rate. As a beginning step, insert the data we have from the problem up to this point into a table.
Income
Rate
Value
Mortgage
.084814
70%
Equity
.090000
30%
Total
100%
By using IRV we can multiply the rate x the value to get the income needed to support this property as shown below. Remember when using percentages it may be helpful to consider the property having a value of $1.
Income
Rate
Value
Mortgage
.05937
.084814
70%
Equity
.02700
.090000
30%
Total
.08637
8.64%
100%
For ad valorem assignments, once the overall rate is developed by the band of investment technique, the appropriate effective tax rate is added to complete the capitalization rate.
To reinforce this topic, we will use the same example giving dollar amounts instead of percentages. The property is worth $1,000,000. Mortgage funds are available for 70% of the property's value at a 7.00% interest rate, amortized over 25 years with monthly payments. The mortgage constant is .084814. Typical investors require a 9% equity dividend rate.
Income
Rate
Value
Mortgage
Equity
Total
$86,370
$1,000,000
Calculating an overall rate from the band of investment technique is straight forward and accurate when market data is available. However, while typical lending terms can be developed from surveys of local lenders, equity dividend rates are more difficult to obtain.
The equity dividend rate is the ratio of annual cash flow (net operating income less debt service) to the original equity investment. It is the equity's capitalization rate. Typically, the equity dividend rate is the investor's anticipated rate of return for the first year of the projection (ownership) period. The equity dividend rate measures both return on and of invested equity capital.
Example: Equity Dividend Rate 14-2
Here is another example using dollar amounts. An office building recently sold for $1,100,000 with a net operating income of $96,500. The property can be financed with a conventional mortgage at a 70% loan to value ratio, 7.00% interest and 25 year amortization (mortgage constant = .084814). What is the equity dividend rate?
Mortgage Amount:
$770,000 ($1,100,000 x .70)
Equity Amount:
$330,000 ($1,100,000 - $770,000)
Net Operating Income
$96,500
Annual Debt Service:
$65,307
($770,000 x .084814)
Annual Cash Flow:
$31,193 ($96,500 - $65,307)
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Equity dividend rates can be developed if the overall rate is known and typical financing terms can be accurately estimated.
Here is another example: An industrial building recently sold for $750,000 with net operating income of $72,000. Similar properties can be financed at a 75% loan-to-value ratio, 7.50% interest rate and 20 year amortization (mortgage constant =.096671). What is the implied equity dividend rate?
Mortgage Amount: $562,500 ($750,000 x .75)
Equity Amount: $187,500 ($750,000 x .25)
Net Operating
Income $72,000
Annual Debt Service: $54,377 ($562,500 x .096671)
Annual Cash Flow: $17,623 ($72,000 - $54,377)
Equity Dividend Rate .09400 ($17,623 / $187,500)
Debt Coverage Ratio Method
The debt coverage ratio (DCR), or the ratio of net operating income to annual debt service, can also be used to estimate an overall rate in conjunction with other mortgage information. The debt coverage ratio is a risk rating measure used by lenders. Its purpose is to provide a margin of net income which exceeds the level of annual debt service. In the event of a decline in net operating income, this margin provides assurance that debt service payments can be maintained.
A commercial property has a current net operating income of $72,000.Debt service payments are $4,925 monthly ($59,100 annually). What is the debt coverage ratio?
NOI $72,000 = ______ DCR
The interrelationship between NOI, annual debt service and debt coverage ratios can be used to determine an overall capitalization rate. This is a simple calculation that multiplies the debt coverage ratio by the mortgage constant and the loan to value ratio to develop a capitalization rate.
Debt coverage ratio x mortgage constant x loan-value-ratio = capitalization rate
The following is an example of how the formula is applied. The net operating income is $66,300 with annual debt service of $54,350.The mortgage is 75% of value with a mortgage constant of .111166 (10.25%/25 years/monthly payments). Lenders require a 1.22 debt coverage ratio.
The calculation to determine the capitalization rate by this method is presented below. With Rm the symbol for the mortgage constant and LTV being the loan to value ratio. Capitalization Rate = 1.22 DCR x .111166 Rm x .75 LTV = .101717 or 10.17%
By combining the terms dictated by the lender (DCR, mortgage constant, and loan to value ratio) a capitalization rate of 10.17% is derived.
Debt coverage ratios increase or decrease depending on the risk associated with a property's income stream. This measure is used in mortgage underwriting but not typically used in assessment appraisals.
This method provides an overall capitalization rate that meets the lenders requirements. Equity investors may seek returns greater returns to equity than provided for by the lenders requirements. In our example, the implied equity dividend rate is 7.34% which may or may not be sufficient to attract equity capital. The calculation of this rate follows:
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Income
Rate
Value
Mortgage
.083375
.111166
75%
Equity
.018343
.073370
25%
Total
.101717
.101717
100%
Effective Gross Income Multiplier/Operating Expense Ratio Method
Capitalization rates can also be extracted from market sales where effective gross income multipliers (sale price - effective gross income) and operating expense ratios (ratio of operating expenses to effective gross income) are available.
The formula for deriving a capitalization rate by this method is as follows: Capitalization Rate = 1 - Operating Expense Ratio (OER)
Effective Gross Income Multiplier
A property recently sold for $825,000. The effective gross income multiplier at the time of sale was 4.85 with operating expense ratio of 45.00%. What is the capitalization rate? Operating Expense Ratio 1 - .45 = .55
EGIM 4.85
Capitalization Rate .5500
4.85 = .1134 or 11.34%
As we learned earlier, IRV represents income / value = rate. In this method (1-OER) actually equals the net income ratio or NIR. The following calculations confirm the EGIM/OER methodology.
Using VIF formula
Sale Price $825,000 / 4.85 EGIM gives Effective Gross Income of $170,103
Effective Gross Income $170,103
Operating Expenses OER (45%) $ 76,546
Net Operating Income $ 93,557
NOI $ 93,557 = .1134 or 11.34%
Sale Price $825,000
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Chapter 14: Deriving Capitalization Rate Challenge
Develop a capitalization rate by market extraction method, mortgage equity band of investment method, debt coverage ratio method and the OER/EGIM method based on the following market information:
Sale Price $1,185,000
Effective Gross Income $167,000 Net Operating Income $100,000 Operating Expense Ratio 40% Debt Coverage Ratio 1.50 Loan-to-value ratio 65% Interest rate 7.25% Amortization period 25 years Annual mortgage constant .086737 Equity dividend rate 8.00%
What is overall capitalization rate using market extraction method?
What is overall capitalization rate using mortgage equity band of investment method?
What is the overall capitalization rate using debt coverage ratio method?
Market extraction method
Using IRV
NOI _________ = __________ Overall Rate
Sale Price
Mortgage equity band of investment method
First, complete the box with the information provided, then complete the box by solving for the missing amounts.
Income
Rate
Value
Mortgage
Equity
Total
Debt coverage ratio method
______ x ________ x _________ = ________
OER/EGIM method
First Solve for EGIM __________/ _______________ = ________
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Chapter 14 Quiz: Direct Capitalization Problems
1.) Show the formula and the value for a property that has a net income of $5,000 and capitalization rate of 12%:
2.) Show the capitalization formula and the capitalization rate for a property that has net income of $12,000 and value of $96,000:
3.) Show the capitalization formula and the net income for a property that has a value of $65,000 and a capitalization rate of 10%:
4.) In question 1, what number represents a ratio between the net income and the property value?
5.) The assessment ratio is 50%, and the tax rate is 45 mills. Calculate the effective tax rate:
6.) An apartment building has potential gross income of $12,000. A study of the market indicates that it is producing economic rent. There is a vacancy and bad debt ratio in this market of 5%. The subject generates miscellaneous income of $1,600 per year (hint: no need to deduct vacancy from this amount). The expense ratio is 40% for comparable properties. The appropriate capitalization rate is 12%. Calculate the value of this apartment building:
7.) You are considering the purchase of a restaurant building. Conventional financing is available at a maximum 60% loan to value ratio, 8.00% interest rate and 20 year amortization and monthly payments. Seller financing is typical for this type of property and the seller will finance 20% of the sale price. Interest would be at 10.00% with a 10 year amortization and monthly payments. You require a 12.00% equity dividend rate. What is the indicated capitalization rate?
Mortgage Constant Loan 1 (Rm) = .100373 (8.00%, 20 year amortization) Mortgage Constant Loan 2 (Rm) = .158581 (10.00%, 10 year amortization)
8.) Which of the following statement is true for developing a capitalization rate using the Debt Coverage Ratio method?
a.) Debt coverage ratio x interest rate x mortgage constant b.) DCR x NIR x OER
c.) Debt coverage ratio x loan to value ratio x mortgage constant d.) (1-OER) / EGIM
9.) A property that sold for $400,000 has an operating expense ratio of 40% and an EGIM of 5.71. What is the capitalization rate?
a.) 7.00% b.) 10.50% c.) 17.51% d.) 10.00%
10.) What data is not required to determine an overall rate by the band of investment technique?
a.) Loan to value b.) Equity dividend rate c.) Mortgage constant d.) Debt coverage ratio
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