When performing a real estate income analysis, the purpose of which is
to determine the market value of an income producing property, a Stable
analysis will nearly always be the best approach.
Stable Income Analysis-Your Benchmark
Every income analysis is inherently a series of forecasts about the future
(some call them guesses). We must forecast the holding period, the
level and direction of expenses, the nature of the economy in the future,
the expectation of yields both now and when the property is sold, the availability
of competitive space when the subject's leases renew, the rate of inflation...
And we have just touched the surface.
Given all of these forecasts, isn't it presumptuous of us to assume that
we can do better than estimating a reasonable market income for the subject
today with the expectation that the income will most likely move in the
same direction and at the same rate as the other indicators that we have
There are, of course, exceptions. And we do realize that there is
often the need to analyze the specific terms of a lease. Commercial
Complete and Investment Analyst are designed to handle the most complicated
of real estate analyses.
But unless you have some way to measure these complicated analyses against a known standard, you cannot possibly be certain that your data entries have produced the results that you expect. You will be forced to manually verify each lease calculation, each renewal option, each number.
When you are performing a Stable analysis, your benchmark is the market. Your estimate of income and expenses is based upon what you have found in the market for similar properties. Your growth rates are extracted from or based upon market growth rates. You can look at the Multiyear Income Statement and
Projected Cash Flow Analysis Report and quickly verify that income and expenses are at the level
that you expect in the first year of your analysis and each subsequent year of
the holding period. You have a reference point - a standard against which you
can compare each year of the analysis.
But when you are performing a Lease by Lease analysis, you can make no
direct comparison to the market with any real confidence unless you have
first established market information. You probably will do this for
the first year. You gather market information on rents and compare
it to the existing leases. But your value is based upon the cash
flows during the entire holding period. How can you compare the data
that you have entered in future years to a standard unless the standard
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We cannot emphasize too strongly the importance of entering good market
data on the stabilized income screen and the stabilized expense screen.
When you do, you will have created a benchmark against which you can measure
your Lease analysis in the first year and each succeeding year of the analysis.
The numbers generated in a Stable analysis will not necessarily be the
same as your Lease analysis. But when your Lease analysis diverges
from the Stable analysis, you will be able to focus on and explain the
The Perfect Property
Imagine as you are developing each Stabilized Analysis that you are appraising the perfect property. There are no leases to restrict your estimate of income. You are free to estimate market rentals. Also imagine that the property could be rented immediately. There is no rent-up period to evaluate. No unusual expenses exist and the expenses are consistent and predictable. Because no leases exist, you are free to project income to grow at a stabilized rate. The growth in value can also be reasonably projected. Fill in the blanks and you have a stabilized analysis. Of course, it is seldom easy to fill in the blanks. However, it is important to stabilize all factors that influence the value calculation.
Ivan A. Thorson, M.A.I. once said:
...proper judgment takes place only when it is brought into relation with some other judgment which has already been tested, and which has found a place in our body of general knowledge. That is, every property is in effect checked against a hypothetically perfect property - an engineer would call it a "bench mark."
Always do a Stablized Analysis First
Even when the subject property is not at stable operation, always perform a stabilized analysis first. When you later switch to a Rent-up Analysis or a Lease Analysis, Analyst will maintain the stabilized entries and compare them with your uneven analysis. When your uneven analysis is compared to a stabilized analysis, potential leasehold interests can be evaluated.When care is taken in developing the Stable Analysis, it becomes our benchmark. For many properties, it will only be necessary to perform a Stable analysis. This is true when income and expenses are currently at or near market and no long term contracts exist which will cause the net income to deviate significantly from our stabilized projections.
information which you enter remains, even when you switch to an uneven analysis
(Rent-up or Lease). You may switch back and forth between stable and non-stable
analysis at any time.
Investment Analyst uses a "top down" macro approach to income
analysis. It is not always necessary or desirable to enter the minute details
of leases. Usually, the analyst of income producing property is better
served by the macro view.
For example, take a typical office building. Most tenants are under 3 to
5 year leases, the range of rental rates varies, different pass-throughs
have been negotiated on a per tenant basis, and the leases expire at different
times. Regardless of the present lease terms for individual spaces, all
leases will tend towards market terms in a relatively short period of time.
A prospective purchaser of the property does have an interest in this lease
detail, but only after evaluating the long term potential of the property
under market assumptions, from the macro view.
We always recommend that our clients first perform a "stabilized"
analysis using market terms. The stabilized analysis becomes your benchmark.
Then, as necessary, an analysis of the leases in place can be compared
to this benchmark. This gives you greater confidence in your final evaluation
of the value of the property. Please see our discussion of Occam's Razor to learn why our approach is usually a better way to perform an income
Investment Analyst offers the capability to perform a stabilized analysis
and a lease analysis simultaneously. It can be as simple as estimating
gross income ($20 per s.f. per year times 100,000 s.f.), estimating a frictional
vacancy rate, and estimating an expense ratio. One can then evaluate the
income stream instantly, under different conditions. For example, one can
change the mortgage terms, alter the growth rate assumptions, or change
the required rate of return. As these conditions are changed, Investment
Analyst provides instant feedback on the cash on cash yield, the debt coverage
ratio, the overall cap rate, the terminal value, and many other key indicators
that are critical to a thorough understanding of the property.
Whether you are an appraiser, a banker, an investor, or a broker, using
the macro view one can quickly determine whether the property meets your
criteria. If it does, Investment Analyst provides the capability of "drilling
down" to the lease detail by allowing you to enter detailed contract
lease terms for all tenants or only selected tenants, as necessary. For
example, most tenant spaces may be at "market" under relatively
short term leases, but one anchor tenant may be under a long term lease
that is above or below market. Detailed lease information can be entered
for just this tenant and the effect upon value can be evaluated.
Our approach differs from most "DCF software" that is available.
Other software typically takes the "bottom up" micro approach.
Lease terms must be entered for each space and critical assumptions that
affect the calculation of value are often hidden in the detail. This is
also true for expenses. Once all detail is entered, the "magic"
number is calculated by discounting the detail - a number that may, or
may not, represent Market Value. This approach to data entry is, perhaps,
good for property managers, but it is prone to user error or intentional
manipulation. Furthermore, errors that have crept into the data entry are
difficult to uncover, especially by a third party. The micro approach is
best applied when one is analyzing the historical or actual cash flows
that have already occurred, in order to calculate the actual yield of those
cash flows. But the "bottom up" approach is not suited for estimating
the value of a prospective income stream because of the inherent assumptions
that must be made about the future.
In summary, Investment Analyst offers both the flexibility to quickly evaluate
income producing property and the sophistication to evaluate complex lease
terms of individual tenants, when necessary. Analyst is easy to use and
its learning curve is short. Investment Analyst provides analysis tools
that are not available in other income analysis products. Key indicators
are at your fingertips. Assumptions are easily changed and the changes
are instantly reflected in the value calculation. Both a stabilized analysis
and a lease analysis can be performed simultaneously. Investment Analyst
has a built-in Review tool that reviews the reasonableness of your inputs.
The reports produced by Investment Analyst are presentation quality, they
are easy to understand, and they are easy to explain
Financial Masterplan, Inc.