"USB242EXPERIENCEPROPERTY WEEK 7 Commercial propertyLecture Outline ? Review Capitalisation Method ? Assessing Market Income ? Introduction to Leases ? Lease Incentives? How to calculate a lease incentive ? Impact of lease incentive on capital value ? Rent Reviews ? Worked examplesCapitalisation Method ? The value of commercial property is determined bythe rental income that the property generates andthe risk associated with this income streamCapitalisation Rate ? Any divisor (usually expressed as a percentage) that isused to convert income into value.? The rate or yield at which the annual net income froman investment is capitalised to ascertain its capital valueat a given date.? The calculation is as follows;property value estimate = net operating income capitalisation rate Source – Property Council of Australia Capitalisation Rate ? The relative risk of this income stream is measuredby the capitalisation rate (cap rate). ? The higher the risk of maintaining the current levelof net rent or profit, then the higher thecapitalisation rate. ? The more stable the income stream, the lower therisk then the lower the capitalisation rate.Risk Return SpectrumSimple Example: Capitalisation Asset Risk Profile Core Core Plus Opportunistic Net Market Income (stabilised) $2,000,000 $2,000,000 $2,000,0005.50% 8.00% 12.00% Capitalisation Rate (Measure of Risk) Estimated Value- before adjustments $36,363,636 $ 25,000,000 $16,666,667Multiple 18 13 8 Cap rates and price/earnings multiples are inversely relatedAs the cap rate goes up, the valuation multiple goes downCapitalisation Rate? Represents the percentage return an investor wouldreceive on an all cash purchase.? One way to think about the cap rate is that it?s afunction of the risk free rate of return plus some riskpremium. ? In finance, the risk free rate is the theoretical rate ofreturn of an investment with no risk of financial loss.? Risk Free Rate: Reserve Bank Cash Rate 1.5%"