BC 2011 10 17 Regular Meeting - Laserfiche WebLink

Home Browse Search

October 17, 2011 (Regular Meeting) BAND OF INVESTMENT Page 749 The Band of Investment method recognizes the Discount Rate as the weighted average of mortgage interest rate(s) based on typical financing; and the equity yield rate, derived from market data. It is based on the premise that investments in income - producing properties are usually financed with a mortgage at the best available terms. The weighting factor is the percentage of the total investment represented by each component contributing thereto. The procedure involved in the Band of Investment method is illustrated as follows: Assume a property is financed with an 80% mortgage at 5 1/20 interest. Equity investors are seeking a 15% return on this type of investment. The indicated Discount Rate would be developed as follows: BAND OF INVESTMENT METHOD FOR DISCOUNT RATE WEIGHTED RATE WEIGHT RATE First Mortgage: .0550 x .80 = .0440 Equity Investment: .1500 x .20 = .0300 Indicated Discount Rate .0740 BUILT -UP METHOD The Built -Up Method involves the "building" of a discount. The discount rate is "built" by taking the current "safe rate" or non -risk of ownership, the illiquidity of the investment, and the burden of management. The SAFE RATE is that rate of return which can be earned annually on a risk free, highly liquid investment requiring virtually no rate which can be earned on a savings account or negotiable 1 year certificate of deposit to the prime lending rate corresponding to the size of the investment. RISK arises from the possibility that the net income forecast will not be realized and refers to the investments continued ability to earn income caused by uncertainties and instabilities in the market place. The allowance for ILLIQUIDITY refers to the marketability or ease with which the investment can be converted to cash. This allowance can be considerable in large or valuable parcels because substantial negotiations may be required and the number of potential local investors may be significantly reduced. The MANAGEMENT allowance refers to the time and effort required to manage THE INVESTMENT, not the property itself. The cost of managing THE PROPERTY is an operating expense which is reflected in the net income statement. Generally, for assessment purposes, real estate taxes are removed from expenses and the applicable county millages are added to the discount rate to arrive at the discount rate applicable to the subject property. BUILT -UP METHOD OF FINDING DISCOUNT RATE For example: Safe Rate 4.5% Risk 2.0% Illiquidity 1.5% Management 0.5% Ad Valorem Taxes 1.5% Total Discount Rate 10.0% The idea of the built -up method is to load the safe rate with rates which reflect the quality of the income stream. The higher the quality, the lower the rate necessary to attract investors. Conversely, the poorer the quality, the higher the rate would be. In essence, the proper interest rate is that