Welcome to
Integra Realty Resources
One Company - Infinite Solutions
1
Edward K. Wadsworth, MAI, CRE
David L. Cary, MAI
INTEGRA REALTY RESOURCES
Boston

INCOME CAPITALIZATION
PRIMER
2
Why Use the Income Approach?
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
Earning power is the critical element
affecting value for investment
property
Best used when valuing Leased Fee
estates, or when valuing Fee Simple
estate for comparative purposes.
Best reflects buyer and seller pricing
decisions for investment property.
What is Fair Cash Value according
to the ATB?



“Fair cash value” means the same as “fair market
value” expressed as the price which someone will
pay for it on the open market.1
“Fair cash value” means the price that an owner
willing but not compelled to sell ought to receive
from one willing but not compelled to buy.2
“Fair cash value” means the same as “fair market
value” expressed as the price which someone will
pay for it on the open market.3
1Donovan
v. City of Haverhill, 247 Mass. 69 at 71
of Quincy v. Boston Consolidated Gas Company, 309 Mass. 60
3Massachusetts Supreme Court Decision, Epstein v. Boston Housing
Authority, 317 Mass. 279 at 299
2Assessors
Income Approach to Value
Critical Elements
Market
Rents
Interest
Rates
Gross
Income
Risk
Leases
Cap
Rate
Vacancy
Expenses
Net
Incom
e
Steps to Follow

Examine Economic Profile of Property

Estimate Gross Potential Income

Estimate an allowance for vacancy and credit loss

Estimate operating expenses

Calculate net operating income before real estate tax (NIBT)

Estimate a capitalization rate

Divide NIBT by Cap Rate to estimate value


Overall Rate (Ro) plus Effective Tax Rate (ETR) expressed as
NIBT/(Ro + ETR)
Adjust for capital improvements needed and/or stabilization
costs.
CASE STUDY – Office Building
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
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Objective is to estimate market value of
leased fee estate and fee simple estate
Multi-tenant office building
Built in 1978
Building size is 19,436 square feet
5,000 s.f. vacant (6-mths to lease)
$10/s.f. TI allowance for new tenant
Good Suburban Location
Economic Profile of Property
Unit
Tenant
Summary of Scheduled Contract Rents
Lease Type Lease Expr.
Sq. Ft.
109 & 101 Home Mortgage Network Gross
212
ZoPonski RE
Gross
210
Computer Services
Gross
102
ABC Hospital
Gross
200
ABC Hospital
Gross
213 & 214 XYZ Law Firm
Gross
108
Dr. Owner
Gross
205
Vacant
Vacant
217
Hometown Psych.
Gross
Gross Scheduled Income (Occupied Space)1
1 Also equal to Base Rental Income
May-08
Aug-09
Sep-09
Jan-10
Nov-10
Jan-10
Feb-09
Vacant
Aug-10
1,715
350
1,125
1,905
4,831
641
2,815
5,000
1,054
14,436
Rent/Sq.Ft.
$16.49
$10.29
$15.57
$25.11
$24.57
$18.61
$23.88
$21.44
$22.00
Rent
$28,276
$3,600
$17,520
$47,831
$118,677
$11,928
$67,222
$0
$22,600
$317,654
Market Rent Estimate
Summary of Competitive Rental Data
Rental
386 N. York St.
Your Town, MA
1220 Hobson
Your Town, MA
242 N. York Street
Your Town, MA
533 W. North Ave.
Your Town, MA
2803 Butterfield Rd.
Your Town, MA
2001 Midwest Rd.
Your Town, MA
Bldg. Age
Size SF
1990's
1,500 to 5,000
1990
1,000 to 5,000
1984
500 to 2,500
1980
500 to 3,000
1980
Varies
1980
Varies
Type of Space
% Occupied
Medical Office
95%
Medical Office
99%
Medical Office
95%
Medical Office
93%
General Office
85%
General Office
95%
Rent/SF
$25.00
$28.00
$22.50
$25.75
$22.00
$21.00
Gross Potential Income
Unit
Tenant
Gross Potential Income
Lease Type Lease Expr.
109 & 101 Home Mortgage Network Gross
Gross
ZoPonski RE
212
Gross
Computer Services
210
Gross
ABC Hospital
102
Gross
ABC Hospital
200
Gross
213 & 214 XYZ Law Firm
Gross
Dr. Owner
108
Gross
Vacant
205
Gross
Hometown Psych.
217
Base Rental Income (Gross Potential Income)
May-08
Aug-09
Sep-09
Jan-10
Nov-10
Jan-10
Feb-09
Vacant
Aug-10
Sq. Ft.
1,715
350
1,125
1,905
4,831
641
2,815
5,000
1,054
19,436
Rent/Sq.Ft.
Rent
$16.49 $28,276
$3,600
$10.29
$15.57 $17,520
$25.11 $47,831
$24.57 $118,677
$18.61 $11,928
$25.00 $70,375
$25.00 $125,000
$21.44 $22,600
$22.94 $445,807
Stabilized Net Income Statement Before RE
Taxes
Historical Operations and Stabilized Forecast (Reconstructed)
Actual
Actual
Stabilized Figures
2005
2006
2007 Per S.F.
Gross Potential Income
$445,807
$22.94
Vacancy and Collection Allowance @ 5%
$22,290
$1.15
Effective Gross Income
Less Operating Expenses Before RE Tax
Insurance
Maintenance and Repairs
Janitorial Services
Depreciation
Mortgage Interest
Utilities
Management
Professional Fees
Reserves
Total Expenses
Stabilized NOI Before RE Tax
NRA = 19,436 SF
Vacancy and Collection Loss = 5%
Management = 5%
$476,589 $420,500
$1,822
$18,356
$16,382
$57,123
$119,756
$28,378
By Owner
$2,893
$0
$244,710
$231,879
$1,987
$68,356
$17,296
$57,123
$115,239
$30,190
By Owner
$297
$0
$290,488
$130,012
$423,517
$2,500
$20,000
$18,000
$0
$0
$31,000
$21,176
$750
$2,900
$96,326
$327,191
$21.79
$0.13
$1.03
$0.93
$0.00
$0.00
$1.59
$1.09
$0.04
$0.15
$4.96
$16.83
CAPITALIZATION
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Capitalization is the process of converting
income into value
One of the main forms of capitalization is
Direct Capitalization
Direct Capitalization is the process of
estimating current value by dividing a single
year’s income by a capitalization rate
Capitalization rate as a basis for taxation
combines an investment rate with the effective
tax rate
How are Investment Cap.
Rates Estimated?
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
Capitalization rates are derived from
comparable sales, investor surveys, or
estimated using financial formulas
For most property types, capitalization
rates are applied to income that has been
adjusted for vacancy and collection loss,
management fees and a reserve allowance
to cover future capital improvements.
Extraction of Capitalization Rate
from Sale Comparable
Commercial Building
Broker Information
Appraiser Adjustment
Gross Income at 100% Occupancy
Vacancy and Collection Loss Allowance
$438,000
$0
$438,000
$21,900 5%
Effective Gross Income (EGI)
Less Operating Expenses
CAM, Insurance, Repairs, Maintenance
Management
Reserves
Subtotal
Net Income
$438,000
$416,100
$135,000
$0
$0
$135,000
$303,000
$135,000
$24,966 6%
$2,500
$162,466
$253,634
Sale Price
Cost of New Roof Needed
Total Investment in Property
Indicated Investment Capitalization Rate (Rt)
$3,100,000
$0
$3,100,000
9.8%
$3,100,000
$50,000
$3,150,000
8.1%
Extraction of Equity Return (Dividend Rate) from
Sale Comparable (RE)
Comparable Office Bldg. Sale
Sale Price
Stabilized NOI w/RE Tax Included
Annual Debt Service: 75% LTV, 5.5% Interest,
25-year loan, Monthly Payments
Cash Flow
Initial Equity (Down Payment)
Cash on Cash Return (RE )
Broker Information
Appraiser Adjustment
$3,100,000
$256,500
$3,100,000
$207,134
$171,330
$171,330
$85,170
$35,804
$775,000
$825,000 *
11.0%
4.34%
Mortgage Equity Formula –
Investment Rate

Combines the requirements of a current
mortgage typical for the subject class of
property, together with the equity return
requirements of an investor.
• Based on 75% LTV, 6.00% Interest, 25 Year amortization
and 5% cash on cash return, the following capitalization
rate is indicated.
Cap Rate = (LTV x RM ) + (% Equity x RE)
Cap Rate = (75% x 7.73%) + (25% x 5%)
Cap Rate = 7.1%
(Next)
Or
Structures
Mtg Loan
Equity (Down Payment)
Portion
75%
25%
100%
Rate
7.73% =
5.00% =
Weighted
Rate
5.80%
1.30%
7.10%
Debt Coverage Ratio Formula

Capitalization rate may be derived
using typical financing criteria
available in the marketplace.
• These criteria include typical debt
coverage ratio*, mortgage constant and
LTV ratio required by lenders
Cap. Rate = DCR x LTV x RM
Cap Rate = 1.20 x 75% x 7.73%
Cap Rate = 7.0%
*The ratio of net operating income to the amount required
for debt service (principal + interest)
Capitalization Rate Surveys
CAPITALIZATION RATE SURVEYS – OFFICE PROPERTIES
IRR-Viewpoint
IRR-Viewpoint
Year End 2007
Year End 2007
Korpacz
Korpacz
ACLI
National
National
4Q-2007
4Q-2007
3Q-2007
CBD
Suburban
National CBD
National
National
Office
Office
Office
Suburban Office
Office
5.0%-11.5%
5.5%-9.0%
4.0%-9.0%
5.0%-10.5%
NA
Range
7.46%
7.42%
6.64%
7.20%
6.10%
Average
Source: IRR-Viewpoint 2008; Korpacz Real Estate Investor Survey; American Council of Life Insurers Investment
Bulletin.
Range of Investment
Capitalization Rates

Extraction from Comparable Sale
8.1%
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Band of Investment Method
7.1%
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Debt Coverage Ratio Method
7.0%
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Cap. Rate Surveys
7.0%
FACTORS THAT IMPACT CAP
RATES
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Quality of Tenancy
Duration of Leases
Terms of Lease
Market Conditions
EFFECTIVE TAX RATE
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Tax Rate per $1,000 of assessed
value ÷ 1,000
Assume CIP Tax Rate =
$15.00/$1,000 of assessed value
Then $15.00/1,000 = 1.5%
Capitalization of Income
Stabilization Costs
-
$1.50/s.f. Leasing Fee
3 months to lease 5K s.f.
$10/s.f. TI Allowance
Stabilization Costs
Leasing Fees
Rent Loss During Absorption
Tenant Improvements
Stabilization Costs
* Gross Rent =
$25
Less Exp. =
$5
Net Rent Loss = $20
5,000SF x $20/SF x .25 = $25,000
$7,500
$25,000 *
$50,000
$82,500
Capitalization
Direct Capitalization of Income
Stabilized NOI Before RE Tax
$327,191
Capitalization Rate**
8.5%
Fair Cash Value As Stabilized
$3,849,306
Less: Stabilization Costs
$82,500
Total
$3,766,806
Fair Cash Value "As Is"
$3,770,000
(rounded)
** Investment Rate + Effective Tax Rate
7% = 1.5% = 8.5%
Reconciliation
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Income approach is most applicable
for income producing properties.
Income approach may not provide a
good estimate of value for properties
suitable for owner-users.
There may be a large disparity
between the results of the income
approach and sales approach for
owner-user properties under current
market conditions.
Case Study Two - Apartment
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4-story, elevator apartment building
63 units
Built in 1930
95% rented
Proposed is refurbishing of 34 units
costing $225,000
Current Scheduled Income is $556,400.
Economic Status of Property
536 W. Main Street, Anytown, MA
Summary of Current Status as of January 1, 2007
One
Contract Rents
Studios
Total
Bedroom
Total Contract Income
$23,805
$22,565
$46,370
Total # of Units
27
36
63
Office/Janitor Apts.
0
0
0
# Eligible for Rent
27
36
63
# Vacant
1
2
3
# Rented
26
34
60
% Rented
96%
94%
95%
Average Contract Rental
$916
$664
$773
Rental Range
$715-$995
$595-$715
$595-$995
Average Size
641
360
481
Avg. Contract Rent/SF
$1.43
$1.84
$1.61
Competitive Rent Survey
Competitive Apartment Rents
Comp. Rental
Location
520 W. Beldon
Anytown, MA
Comments:
440 Fullerton
Anytown, MA
Comments:
1936 N. Clark St.
Anytown, MA
Comments:
Type
Monthly
Rents
Rent/SF
One Bedroom - 550 SF
Studios - 425 SF
$960
$680
$1.74
$1.60
1920's vintage, 5-story, elevator apartment building. Heat is
included in the rent. Fitness center. No on-site parking. Units
in average condition.
One Bedroom - 550 SF
Studios - 450 SF
$1,000
$800
$1.18
$1.78
1920's vintage, 5-story, elevator apartment building. Heat is
included in the rent. No amenities. No on-site parking. Units
have been renovated.
One Bedroom - 550 SF
Studios - 450 SF
$1,100
$800
$1.69
$2.00
1920's vintage, mid-rise, elevator apartment building. Heat is
included in the rent. Fitness center, sun deck. No on-site
parking. Units have been renovated.
Analysis of Competitive Rents
Rent Comparison Grid
Complex
Rent: 1Bdrs
Rent: Studios
Rent PSF 1Bdrs
Rent PSF Studios
Adjustments to PSF
Location
Age/Updating
Utilities
Amenities
Parking
Net Adjustment
Adjusted PSF Rents
Rent PSF: 1Bdrs
Rent PSF: Studios
1
$960
$680
$1.74
$1.60
2
$1,000
$800
$1.81
$1.78
3
$1,100
$800
$1.69
$2.00
0.0%
10.0%
-5.0%
-2.5%
0.0%
2.5%
0.0%
0.0%
-5.0%
2.5%
0.0%
-2.5%
-10.0%
0.0%
-5.0%
-2.5%
0.0%
-17.5%
$1.78
$1.64
$1.76
$1.74
$1.39
$1.65
Market Rent Estimate
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Market Rent for One-bedroom units are
estimated to average $1,000 or
$1.56/s.f.
Market Rent for studios are estimated to
average $700 or $1.94 per square foot.
Total potential market rent is calculated
below
27, 1-bedroom @ $1,000/month x 12 months =
36, studios @ $700/month x 12 months =
Stabilized Gross Potential Apartment Income
$324,000
$302,400
$626,400
Stabilized Income Statement
Year
Gross Rents
Laundry Income
Total Gross Potential Income
Stabilized
Actual 2005 2006
$626,400
$9,500
$635,900
Less Vacancy and Collection Loss @ 5%
Effective Gross Income
Less: Operating Expenses Before RE Tax
Advertising
Insurance
Janitor
Legal and Professional
Maintenance and Repairs
Management and Office
Other Expenses
Painting and Decorating
Scavenger
Supplies
Utilities
Reserves
Total Expenses Before RE Tax
Net Operating Income Before RE Tax
* $250/Unit
$31,795
$567,235
$1,500
$16,000
$16,000
$3,500
$2,450
$0
$500
$5,000
$3,000
$3,000
$13,580
$0
$64,530
$502,705
$604,105
$2,000
$16,000
$16,000
$2,000
$15,000
$31,795
$500
$15,000
$3,000
$3,000
$14,000
$15,750 *
$134,045
$470,060
Comparative Analysis of Expenses
Comparative Analysis of Expenses
Apartment Complex
Year of Expenses
Number of Units
% Total Expenses
% Taxes
% Other Expenses
Subject
2006
63
44%
22%
22%
LaSalle
2006
41
37%
16%
21%
Kenmore
2006
59
44%
16%
28%
Wolcott
2006
46
39%
13%
25%
Expenses Per Unit
Expenses w/o Taxes
$4,191
$2,128
$6,098
$3,434
$2,747
$1,730
$3,045
$2,001
$8.71
$4.42
$7.52
$4.23
$6.48
$4.08
$5.83
$3.83
Expenses Per SF
Expenses PSF w/o Taxes
Extraction of Investment Cap. Rates
From Sales
Sale
Address
Subject Property
536 W. Main Street
Anytown, MA
NA
NA
63
27-1's & 36-0's
One/Four
162
1930
Elevator
None
Laundry
Good
By Tenant
1
1824 N. Lincoln Pk
Anytown, MA
Jun-05
$3,810,000
37
24-0's, 12-1's, 1-2's
One/Five
82
1920's
Elevator
33
Laundry
good
By Landlord
2
532 Belmont
Anytown, MA
Apr-06
$5,700,000
45
60-0's, 27-1's, 12-2's
One/Three
155
1925
Walk-up
None
Laundry
Average
By Landlord
3
550-560 W. Adeline
Anytown, MA
May-06
$4,550,000
38
32-1's, & 6-2's
One/Three
139
Vintage
Walk-up
None
Laundry
Average
By Landlord
$635,900
$31,795
$604,105
$134,045
$470,060
$375,000
$18,750
$356,250
$151,750
$204,500
$560,000
$28,000
$532,000
$212,000
$320,000
$432,000
$21,600
$410,400
$150,400
$260,000
Capitalization Rate
GIM
Expense Ratio
NA
NA
22.2%
$0
10.16
42.6%
$0
10.17857143
39.8%
$0
10.53240741
36.6%
NOI Per Unit
Sale Price Per Unit
$7,461
NA
$5,527
$102,973
$7,111
$126,667
$6,842
$119,737
NOI Per Room
Sale Price Per Room
$2,902
NA
$2,494
$46,463
$2,065
$36,774
$1,871
$32,734
Date of Sale
Gross Sale Price
# Units
Apts. Mix
#Bldgs/#Stories
Rooms
Age
Style
Parking Spaces
Amenities
Condition
Heat Paid
Gross Income (GI)
Vacancy Allowance
Effective Gross Income
Expenses
Net Income (NOI)
Range of Investment Cap. Rates


Extraction From Comparable Sales = 5.6%
Band of Investment method
(75% LVR, 30yr loan w/monthly pmts., 6% interest rate, RE)
(.75 x .0719) + (.25 x .06) = 6.9%

Debt Coverage Ratio
LVR x DCR x RM = .75 x 1.2 x .0719 = 6.5%

Investor Surveys = 6% (see next page)
Investor Surveys
CAPITALIZATION RATE SURVEYS – MULTIFAMILY PROPERTIES
IRR-Viewpoint
IRR-Viewpoint
Korpacz
ACLI
Year End 2006
Year End 2006
1Q-2007
4Q-2006
National
National
National
National
Urban
Suburban
Apartment
Apartment
Multifamily
Multifamily
4.0%-10.0%
4.0%-8.4%
3.5%-8.00%
NA
Range
6.70%
6.44%
5.89%
6.10%
Average
Source: IRR-Viewpoint 2007; Korpacz Real Estate Investor Survey; American Council of Life Insurers Investment
Bulletin.
Effective Tax Rate


$15.00/$1,000 AV = $15 / 1,000 = 1.5%
Capitalization Rate of Tax Purposes
6% + 1.5% = 7.5%
Stabilization Costs





Proposed for construction of 34 units costing $225,000
Six months to complete construction and to achieve stabilization
of income.
The income lag represents 50% (6 months) of Gross Rent for 34
units.
Leasing Fees are based on one month’s rent for 34 units.
Profit incentive is estimated to be $150,000.
Less: Hard Costs for Improvement Costs
Less: 6-months Income Lag
Less: Leasing Fees for 34 units
Less: Profit Incentive
Total Stabilization Costs
$
$
$
$
$
225,000
169,028
28,500
150,000
572,528
Capitalization of Income
Direct Capitalization of Income Before RE Tax
Stabilized NOI Before RE Tax
Capitalization Rate for Tax Purposes
Stabilized Market Value
Less: Stabilization Costs
Total
Fair Cash Value For Tax Purposes "As Is"
$470,060
7.5%
$6,267,467
$572,528
$5,694,939
$5,700,000
Integra Realty Resources –
Boston
Edward K. Wadsworth, MAI, CRE
David L. Cary, MAI