BC 2011 10 17 Regular Meeting - Laserfiche WebLink

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October 17, 2011 (Regular Meeting) Page 751 the capital recovery rate. It must be remembered that the central objective is the valuation of a finite income stream with the "infinite" value of the site. IDENTIFY METHOD OF CAPITALIZATION TO USE Capitalization is a process whereby an income stream of future payments is discounted to a figure which represents the present worth of the right to receive the income. The basic relationship between the income and value is expressed as follows: Value = Net Operating Income /Capitalization Rate There are seven methods in PASCO which employ the capitalization technique to derive a value for an income producing property. Each has the same basic theory - that a right to receive a future value may be determined by discounted cash flow analysis which properly corresponds to the characteristics of the inflows and outflows of income. Each of these methods is detailed in the following pages with specific examples. METHODS OF CAPITALIZATION LAND RESIDUAL When the building is fairly new, free of obsolescence, and the replacement cost accurately determined, a land residual technique may be used to estimate the value. Land Residual Straight Line If economic rent is applicable (short term lease or rental or less than first class tenants), straight line technique should be used as follows: Given:Building Value (based on replacement cost new) $100,000 Net Operating Income $15,000 Discount Rate 10% Remaining Economic Life 50 years Straight Line Capital Recovery Rate 1/50 = 2% Net Operating Income $15,000 Less Annual Income allocated to building - $12,000 ($100,000 x .12) Equals Income allocated to Land $3,000 Present value of the Land equals annual income allocated to land capitalized at the discount rate. ($3,000 divided by .10) $30,000 Plus current building value $100,000 Estimated value via Income Capitalization Straight Line Land Residual Technique $130,000 LAND RESIDUAL - LEVEL ANNUITY If contract rent is applicable (long -term lease with prime tenants) the land residual, level annuity technique should be used as follows: Net Operating Income $15,000 Less annual income allocated to building (Building value divided by PW of 1 per Annum @ 10% for 50 years) 100,000 9.915 - $10,086 Equals income allocated to land $4,914 Present Value of Land equals Annual Income allocated to land capitalized at the Discount Rate ($4,914 divided by .10) $49,140 Plus current building value $100,000 Estimated Value via Income Capitalization Level $149,140