In Chapter 8 the book discusses several methods of evaluating income producing p
ID: 2658169 • Letter: I
Question
In Chapter 8 the book discusses several methods of evaluating income producing properties. The three methods discussed are Direct Capitalization (Cap rate method), Discounted Cash Flows (DCF), and Effective Gross Income Multiplier (EGIM). Direct Capitalization utilizes only the 1st Year NOI, and a market extracted cap rate (Ro) to determine the value of a property. (V- NOl/Ro DCF method estimates the holding period, NOI for each year the property is owned, and the estimated sales proceeds when the property is sold. The present value of these cash flows is then discounted at an appropriate discount rate to determine the present value which is equal to the value of the property. Clearly this is a more involved analysis than direct capitalization. EGIM is similar to the cap rate method xcept it utilizes Effective Gross Income (EGI) instead of NOI and a multiplier instead of a cap rate. This type of analysis works best for properties where the operating expenses do not vary significantly across comparable properties. Based on the descriptions above, and after reading chapter 8, answer the following questions: 1) What types of properties would the use of EGIM be appropriate? Explain why. 2) Why do you think that the Direct Capitalization method can produce results as accurate as a DCF analysis when it clearly uses a much more simplistic approach? Explain your answer 3) If you were an investor which method of valuation would you find the most appealing/convincing.Explanation / Answer
Answer.
1. EGIM: This represents the relationship between sales value and effective gross income. In this the rate is not used as a percentage but as a multiplier.
This method is used for properties, like
These properties are using this method because;
2. I do not think that the Direct Capitalization Method can produce results as accurate as a DCF analysin because both these methods are appropraite in certail circumstances. Direct Capitalisation is well suited for properties expected to have stable NOI. wherein DCF is well suited for properties expected to have fluctuatiung NOI.
A major benefit with DCF analysis is that it included careful consideration of expected supply and demand for a particular type of property.
3. If i was an investor, i would choose DCF method as a most convincing method for evaluating income producing properties.