BC 2011 10 17 Regular Meeting - Laserfiche WebLink

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October 17, 2011 (Regular Meeting) Page 750 rate necessary to attract capital to the investment. IDENTIFY METHOD OF DEPRECIATION The wearing out and /or obsolescence of the improvements is reflected in the projected holding period or in the remaining life of which enables the investor to recoup or recapture his initial capital investment while also receiving a return on his capital. Every method of providing for capital recovery can be expressed in the form of a sinking fund. A specific sum is to be recovered over a specific period of time. Periodic annual payments are made as part of NOI to cumulate to the full amount of capital to be recovered by the end of the capital recovered period. There are basically two methods of providing for capital recovery each with specific assumptions as to the risk, timing, and stability of the net income stream. STRAIGHT -LINE CAPITAL RECOVERY This method consists of recovery by equal annual payments to a sinking fund which cumulate at zero compound interest. Each successive payment reduces the amount of investment remaining; each successive income payment also declines. A declining dollar return from the investment is therefore forecast. Capital recovery payments are the largest under this method. The rate determined by dividing the amount of capital loss to be recovered (100 %) by the number of years of remaining ECONOMIC LIFE. For example: remaining Economic Life of Improvement - 25 years 100 % /25 = 1.00/25 = .04% Value of Improvements: $100,000 Annual portion of NOI required to cover capital recovery: $100,000 x .04 = $4,000 The forecast loss of 100% of the improvements is fully recovered over the Remaining Economic Life of the improvements. Hence, straight -line capital recovery always results in a lower estimate of present worth or value than does any other method. Straight -line capital recovery is widely held applicable to nearly all income flows that are not based on a long -term lease with a highly rated tenant. LEVEL ANNUITY CAPITAL RECOVERY This method can be described as equal annual payments to a sinking fund which are reinvested by the investor to cumulate at compound interest at the Discount Rate. The amount of capital recovery payments is relatively small compared to the straight -line method. As a result the portion of NOI available each year as a return on the investment is larger. The rate is calculated using the compound interest table or in the case of PASCO the capital recovery rate is internally computed saving the property appraiser from having to compute the figures manually or have on hand volumes of financial tables. The Sinking Fund Factor Formula is included here solely for reference purposes: 1 1SN = i/ (1 +i) nl where 1 = The number one i = The discount rate (also the rate at which capital recovery payments are compounded). n = The number of compounding periods (usually the remaining economic life). 1 /sn = The Capital Recovery Rate Annuity Capital Recovery can be applied to those properties that have a relatively stable income producing capability. By calculating the necessary factors internally, PASCO saves the appraiser from many of the "mechanical" steps which would otherwise be necessary. The preceding discussion has detailed how the net operating income is derived and also the various components of the Capitalization Rate. A Capitalization Rate can be derived arithmetically by adding together the discount rate and