Real Estate Investment: Market Rent - Assignment Example

Market Rent  Question Market rent is described as the amount willing tenants reasonably expect to payas rent for their tenancy and the amount a willing landlord reasonably expects to receive as rent for premises vis a vis rent levels of properties similar to the one in question. Market rent is a vital guide when deciding on the rent of a given space. The law stipulates that the rent of premises should be comparable with similar properties of same type location and size. It short, market rent is the generally accepted amount of lease or rent on space either for commercial or residential purposes. For instance, a 4000 square feet space can be leased at £1000 since similar spaces are leasing at this price in the local market. In this case, the £ 2000 is the market rent. In the US market, rent laws appear in tittle 24 of the federal registry subtitle B Chapter IV par 401-subparagraph C-section 401.410. These statutes describe the standards for determining comparable market rent. In New Zealand, market rent statutes are outlined in the Residential Tenancies Act. In the UK, several statutes and laws such as the Tenancies order 2006, Housing Act, Rent Order 1978 etc. play a big role in determining the market rent. Several challenges face rental premises appraisers. There are a number of techniques used by investors and rental property values to determine the value of a given property. In this section, we outline three techniques used and the challenges each technique poses. Sales Comparison Approach This technique is one of the most recognized methods of valuing residential property. In this approach, a comparison of similar properties that have been sold or rented within a stipulated period is done. In this technique, a price value is assigned say price per square foot. If for instance a 1000 square foot property is renting for £1 per square foot, it should be expected that similar properties in the area have a similar rent range. The biggest challenge when using sales comparison approach to value property is that SCA is generic. Every home/ property is unique and cannot always be quantifiable. Sales comparison approach can only act as a baseline or a reasonable estimate and not a perfect predictor in the valuing of rental property. To mitigate this challenge, investors should employ the services of a qualified appraiser. Capital Asset Pricing Model This technique is comprehensive as it applies risk and opportunity in relation to the property. This model of valuing rental properties reviews the return on investment of the property as compared to a risk free investment. If the return on investment can be matched by the risk free investment, then it makes no financial sense to invest in the property. This technique considers inherent risks such as location and age of the property. For example, a landlord renting an older property may incur more cost in renovation hence a higher risk compared to one renting a property that requires no renovation. This technique of valuing rental property is effective for determining how much an investor deserves for risking their money on a given property. The biggest challenge in this technique of valuation is that the beta coefficient and the average market return necessary for calculating the return on investment may vary depending on assumptions and accounting principles. Some of the assumptions made may not always be true hence; the values generated cannot be relied upon one hundred percent. Income Approach This approach focuses on the potential rental income the property is likely to yield relative to the initial investment. In this method, determining the annual capitalization rate for an investment is imperative. This rate is simply the expected annual income from rent multiplier divided by the original or the current value of the property. The challenge with this method of valuing property is that quantifying certain aspect of the annual capitalization rate can be difficult. To capture the real value of the annual capitalization rate, interest on mortgage; the fact that the future rental income may vary and the net present value of money must be captured. These values are not easily quantifiable and at best are only estimates. Cost Approach. In this technique, property is valued based on its real worth. This is done by summing the land value and any improvements done on the land. This technique is often used in valuing vacant land and new properties. This technique of valuing property is only effective when valuing new structures and may not be as useful when valuing older ones. This approach may not be useful when evaluating certain properties. Question 2 This report will do an appraisal on a property based on two approaches. Specifically these approaches include capital valuation and comparable evidence. The property of interests is a retail property near a major rail terminus. (No 7 Station Road) The property is on a 10yr FRI lease. The shop has 8m frontage and a depth of 18 meters with no return frontage. Comparable evidence. Comparable evidence is based on substitution. Comparison between properties of interest with Comparable R1 Property of interest Dimension Frontage 8m Depth. 18m Lease FRI 10 years Comparable R1 Dimension Frontage 12m Depth. 20m Lease FRI 10 years Rent passing £ 29,000 Comparative R1, which is on 35 stations Road, and 50 meters away provide a good ceiling estimate on what the property of interest could cost in rent. The rent of Comparative R1 shows a rent cost which the property of interest should not exceed. Reason. 1) The dimensions of comparative R1 are higher compared to those of the property of interest. 2) The lease of both properties is almost similar. 3) Comparative R1 is located 50 meters from the property of interest. Comparison between properties of interest with Comparable R2 Comparative R2 Dimension Frontage 7 m Depth. 16m Lease FRI 15 years Rent pasing £ 17,500 Comparative R2 located at 10 Back roads provides a rent estimate closer to what our property of interest should be rented. Reason 1) The dimensions are much closer to those of the property of interest. 2) Lease is almost similar 3) Comparative R2 is located at an area that is near to the property of interest. Comparison between properties of interest with Comparable R3 Comparative R3 Dimension Frontage 5m Depth. 8m Lease A1 Rent pasing £10,500 Comparison between comparative R3 located in 1 The parade and the property of interest show the rent amount that the property of interest should not be rented below. Reasons 1) Smaller in dimension 2) Similar lease basis 3) Proximity to the property in question. Capital valuation Estimates of the cost property of interest Comparative R2 has a yield of 5.2% and a rent pasing of £ 17,500. Based on this yield we can calculate the property cost Property cost of Comparative R2= Rent p.a/ Yield =14,000/0.5 =£ 269,231 Property cost of Comparative R2= Rent p.a/ Yield =10,500/5.5% =£ 190,909 Implications. The property of interest should be rented for a cost not above £29,000 p.a and not below £ 10,500 p.a. The rent should also be slightly above £ 17,500 p.a The property cost of the above property should be slightly above £ 269,230 Read More