If you have investing in a note or are thinking of investing in one, of your first thoughts will be to the value of the note – how much is it worth and how much can you buy or sell it for?
So you’re probably wondering how to understand the value of a real estate note in Phoenix note buyers and sellers.
There isn’t an easy answer but in this blog post you’ll learn some of the ways that a note can be valued, to make you better informed…
How To Value A Real Estate Note For Phoenix
While note all of these factors will influence the value of every note, it’s important to see how a note can be valued. Probably the best strategy is to get in touch with us and we can help you understand how we value the notes we sell. Reach out to our team by clicking here or by calling (480) 744-5941.
- You can value a note by the amount owed on the note, including both the principal and interest owning.
- You can value a note by whether or not it’s a performing or non-performing note (although the definition of performing versus non-performing varies, in general you’ll find that a non-performing note is one where the person who is supposed to be paying the underlying mortgage is not paying it back. It’s important to note that non-performing notes still have a value!)
- You can value a note by what position that note has in a line-up of mortgages on the property (such as a first position or a second position).
- You can value a note by how much equity is in a note (notes may be equity, partial equity, or no equity).
As you can see, there are many factors that can go into how to value a real estate note for AZ note buyers and sellers. In some ways, even the economy and the location of the property will play a factor in the value of the note, since houses in some areas might be priced lower than houses in other areas.
If you’re thinking about investing in notes, you also need to remember this: the value of a note is not just the specific price of how much the note costs to invest in, but rather how much value you’ll get out of the note once you’ve invested in it.
Example: Consider two investments – a portfolio of performing notes or, for the same price, a rental property. Different investors may have different opinions on which one is valued higher even if they could be bought for the same price… but the portfolio of performing notes will generally produce cash flow little or no work while the rental property may require a lot of work to maintain. (Note: this is a simplification for illustration purposes only; of course there are other factors at work here!)
The Market-Extraction Method
The market-extraction method assumes that there is current, readily available NOI and sale price information on comparable income-generating properties. The advantage of the market-extraction method is that the capitalization rate makes the direct income capitalization more meaningful.
It is relatively simple to determine the capitalization rate. Assume an investor might buy a parking lot expected to generate $500,000 in NOI. In the area, there are three existing comparable income-producing parking lots:
- Parking lot 1 has NOI of $250,000 and a sale price of $3 million. The capitalization rate is 8.33% ($250,000 / $3,000,000).
- Parking lot 2 has NOI of $400,000 and a sale price of $3.95 million. The capitalization rate is 10.13% ($400,000 / $3,950,000).
- Parking lot 3 has NOI of $185,000 and a sale price of $2 million. The capitalization rate is 9.25% ($185,000 / $2,000,000).
Taking the average cap rates for these three comparable properties an overall capitalization rate of 9.24% would be a reasonable representation of the market. Using this capitalization rate, an investor can determine the market value of the property they’re considering. The value of the parking lot investment opportunity is $5,411,255 ($500,000 / 0.0924).
The Market-Extraction Method
The market-extraction method assumes that there is current, readily available NOI and sale price information on comparable income-generating properties. The advantage of the market-extraction method is that the capitalization rate makes the direct income capitalization more meaningful.
It is relatively simple to determine the capitalization rate. Assume an investor might buy a parking lot expected to generate $500,000 in NOI. In the area, there are three existing comparable income-producing parking lots:
- Parking lot 1 has NOI of $250,000 and a sale price of $3 million. The capitalization rate is 8.33% ($250,000 / $3,000,000).
- Parking lot 2 has NOI of $400,000 and a sale price of $3.95 million. The capitalization rate is 10.13% ($400,000 / $3,950,000).
- Parking lot 3 has NOI of $185,000 and a sale price of $2 million. The capitalization rate is 9.25% ($185,000 / $2,000,000).
Taking the average cap rates for these three comparable properties an overall capitalization rate of 9.24% would be a reasonable representation of the market. Using this capitalization rate, an investor can determine the market value of the property they’re considering. The value of the parking lot investment opportunity is $5,411,255 ($500,000 / 0.0924).
The Band-of-Investment Method
With the band-of-investment method, the capitalization rate is computed using individual rates of interest for properties that use both debt and equity financing. The advantage of this method is that it is the most appropriate capitalization rate for financed real estate investments.
The first step is to calculate a sinking fund factor. This is the percentage that must be set aside each period to have a certain amount at a future point in time. Assume that a property with NOI of $950,000 is 50% financed, using debt at 7% interest to be amortized over 15 years. The rest is paid for with equity at a required rate of return of 10%. The sinking fund factor would is calculated as:
\begin{aligned}&SFF=\frac{i}{(1+i)^n-1}\\&\textbf{where:}\\&\text{SFF}=\text{Sinking fund factor}\\&i=\text{Periodic interest rate, often expressed as an}\\&\phantom{i=}\text{annual percentage rate}\\&n=\text{Number of periods, often expressed in years}\end{aligned}
Plugging in the numbers, we get:
- 0.07 / (1 + 0.07)15 – 1
This computes to 3.98%. The rate at which a lender must be paid equals this sinking fund factor plus the interest rate. In this example, this comes out to 10.98% (0.07 + 0.0398).
Thus, the weighted average rate, or the overall capitalization rate, using the 50% weight for debt and 50% weight for equity is:
- 10.49% [(0.5 x 0.1098) + (0.5 x 0.10)]
As a result, the market value of the property is:
- $9,056,244 ($950,000 / 0.1049)