The theory behind the Income Approach to value is that property values reflect the present worth of anticipated or forecasted future benefits from the real estate. As such, the Income Approach analyzes the income attributable to the real estate and converts this net revenue into an estimate of current value.
In general, there are two methods available for converting future income into a present value:
- a direct capitalization method,¹ or
- discounted cash flow analysis.
Either type of analysis recognizes that money has a time value. That is, given a choice, people would rather receive $100 today than $100 one year from now. However, certain people would rather receive $110 ($100 + 10%) in one year than $100 today. The interest rates applied to convert future dollars to cash in the pocket today reflect the time value of money.
The valuation technique commonly used by assessors across Canada is based on the Direct Capitalization method, which is widely accepted as a mass appraisal technique and under existing jurisprudence.² Also, it is relatively easy to use.
The Direct Capitalization Method
The analysis in this section presents a direct capitalization method that is suited for mass appraisal applications. Therefore, the analysis focuses upon typical golf course properties.
In addition, whenever possible, the capitalization rates employed in the process should be derived from market transactions involving sales of similar golf courses subject to similar zoning restrictions.
Direct capitalization converts or capitalizes the expected level of current net earnings into an estimate of market value using a capitalization rate. Therefore, the conversion factor or capitalization rate is a reflection of all of the investor’s relative and comparative feelings and aspirations about the property in light of the investment characteristics offered by the asset and in comparison to other investment opportunities on the market.
In its most basic form, the Direct Capitalization method is an elementary mathematical ratio involving the estimation of current net operating income (NOI), which is then capitalized into value to produce an estimate of current market value.
Market Value |
= |
Net Annual Operating Income |
V |
= |
NOI |
|
|
Capitalization Rate |
|
|
R |
For example: |
NOI |
= |
$100,000 |
|
|
|
|
|
Cap Rate (R) |
= |
10% |
|
|
|
|
|
Market Value |
= |
$100,000 |
/ |
0.10 |
= |
$1,000,000 |
Although there are other methods of converting expected future income into an estimate of current value (e.g., discounted cash flow), the direct capitalization method lends itself to mass appraisal applications. It is possible to ascertain market values under this formula through proper evaluation of the expected net income and through the selection of an appropriate capitalization rate.
It is very important to ensure that the method used to derive capitalization rates is consistently applied when valuing the courses. (Westcoast Transmission vs. Assessor of Area 9 - Vancouver)
¹ Re: Campeau Developments Ltd. and the Regional Assessment Commissioner Region No. 29 (1982) 144 D.L.R. (3d) 632 (C.A.) Leave to appeal to S.C.C. refused 51 N.R. 154 m.
British Columbia v. 359042 B.C.Ltd. [1997] BC No. 1459
² Bramalea Ltd. v. British Columbia Assessor Area # 9, Vancouver (1990) 76 D.L.R. (4th) 53. (C.A.) Leave to appeal to S.C.C. refused 79 D.L.R. (4th) vi. 135 N.R. 318 m. |
