Calculating Future Property Value
The income return is typically calculated as the ratio of the property’s net operating income (NOI) over its market value or acquisition price. The appreciation return is typically measured as annualized increase in value over the holding period (minus any sales costs). For the after-tax appreciation return we need to deduct of course taxes on capital gains. The typical income return for residential, retail and office property in the US ranges from 5% to around 8% depending on the property type under consideration. Within this context, achieving double-digit returns requires decent increases in property value over the investment’s holding period. Thus, the expected future property value at the end of the holding period needs to be high enough so as to provide a decent annual appreciation return after capital gains taxes and sales costs are deducted. Future property value can be calculated using three techniques: 1) By applying an average/constant annual growth rate to the current property value 2) By using the econometric property value forecasting technique, which requires the following two steps in order to be applied to a particular property: a) produce year-by-year forecasts of property value growth rates for the property type that represents the property under consideration and for the market within which the property is competing using robust econometric techniques
3)The third methodology for calculating future property value, which applies to income producing properties, involves the following three steps: a. Produce year-by-year forecasts of rent growth rates for the property type that represents the property under consideration and for the market within which the property is competing using robust econometric techniques b. Produce annual forecasts of the net operating income (NOI) of the property under consideration over the holding period taking into account its existing lease roll and by applying the econometric forecasts for market rent growth (adjusted to reflect the idiosyncrasies of the property and its location) to expected lease renewals and to new leases expected to be signed for vacant space c. Calculate the future property value for the expected year of exit from the investment (let’s say at t+n where t is the time of analysis and n is the number of years the property will be held) by dividing the property’s expected NOI at t+n over the market cap rate CR at time t+n: Future Property Valuet+n = NOIt+n/CRt+n |
