I recently got an email from a reader asking about valuation of a target property and thought this was a good time to recap what we have learned so far. Let me share with you an excerpt from that email…

From: xxxxxxxxxx@yahoo.com.ph
To: moderator@realestateinsight.ph
Sent: Tuesday, June 1, 2010 2:41:17 PM

Subject: Advice with Fort Condo

My husband and I are both working but we feel the money we save will never be enough to cover our retirement. We already have a house in Quezon City and are now looking at buying a ready to occupy condo at the fort. Our agent tells us that it is an excellent investment and is pushing us to close the deal. My question is how do we know if it really is a good buy? Is there a formula we can use? Any advice you can offer will be greatly appreciated.

At the risk of sounding like an advice column, which I don’t mind really, I’d like to respond to this email via this blog post…

I actually have several insights for xxxxxxxxxx@yahoo.com.ph. First, don’t ever let yourself get bullied (pushed) into a deal. Even if it sounds like a good one, it always pays to do the math first before jumping into something as important as real estate investment. That said, let me tell you about a post we did a few weeks back… This was about CapRate (Capitalization Rate). CapRate is a performance ratio that quickly tells you what the Value of a Target Property should be by comparing it with similar properties. Let us look at the example below and see how we can use CapRate to determine if the Value of a property being offered is at par or better than market…

Lets assume we are being offered a 1Br Unit in Serendra for Php 6 Million. We know that CapRates in Serendra (Fort Bonifacio) are at 8%. We also know that rents for 1Br units would give us a Net Operating Income of about Php 600,000 yearly.

So, to determine if Php 6 Million is a good price, let us follow the formula below…

Value = Net Operating Income / Capitalization Rate
Value = 600,000 / 8%
Value = Php 7.5 Million

From the calculation above, we can see that an NOI of 600K and 8% CapRate translates to a Market Value of Php 7.5 Million. This tells us that a purchase price of Php 6 Million is below market and offers a good 20% (Php 1.5 Million) discount.

You can use the same example above to see whether the property being offered is a good deal. Take note that the CapRate for Serendra may be different from the property being offered to you. Its best to ask your agent/ broker what the Property’s CapRate is. If your agent doesn’t know, look for another one. This is basic information that any good Realtor should know.

The single thing almost all investors have in common is the desire to know the answer to the question “How much will I make on my investment?“. Put another way, investors want to know what the return on their invested dollars will be, or what their return on investment will be (ROI). The ROI performance measurement or Yield, as it is sometimes referred to, can be applied to measure the effectiveness of all types of assets and is especially useful in real estate. The ROI measurement captures the relationship between Net Operating Income and Invested Capital, Cash Flow and Invested Capital and the Asset’s Total Return versus Invested Capital.

The first of these “ROI” measurements is Net Income ROI, or the relationship of the Net Operating Income (NOI) versus your Invested Capital. This is helpful to investors who focus primarily on the traditional income statement. Net Operating Income is derived by subtracting all items classified as expense from gross revenues. NOI is calculated both before and after taxes. I posted a PDF Form that should help to calculate your NOI. You can download it again here.

Important Note: When applying an expense item to Mortgage, it is important to remember that the interest portion of that payment should be applied and not the principal portion. The principal portion is treated as a balance sheet item and has no effect on the income statement.

The formula for NOI Yield is;

gross income – operating expense – interest cost – depreciation – taxes
= ———————————————————————————–
owner’s equity (invested capital)

Example:

• Property: 400 Square Meter Office Condo in Makati
• Acquisition Cost or Invested Capital is: Php 20.5 Million
• (Please do not include VAT since that is creditable)
• Gross Income from Rent: Php 3.0 Million Annually
• Operating Expense: Php 106,000.00
• Corporate Income Tax 35%: Php 1.0 Million

Using the formula and assumptions above, we calculate our NOI Yield as follows;

3.0 Million – 106,000 – 1.0 Million
= ——————————————
20.5 Million

Net Operating Income Yield = 9.2%

The complete excel worksheet is attached and can be downloaded here. Feel free to use and revise as necessary.

So what does a 9.2% yield mean to you? As we discussed during the last issue, Performance Measurement is RELATIVE. Compared to other investment instruments 9.2% may not seem that attractive but once you consider the level of risk, the proposition takes on new meaning. Furthermore, if you compare the same return to instruments of its kind, a 9.2% yield for an Office Condo in Makati is something you will not want to miss.