Chapter 9: Capitalization, Taxation and Closing Adjustments

Capitalization - the appraisal process consists of direct comparison, cost, and income approaches.

Direct vs. Yield Capitalization (капитализация доходности)

Direct capitalization is based on a single year's projected income and expenses in arriving at a value. Yield cap. req. forecasted income and expenses over a projected investment period (3-5 yrs) and involves 4 steps: 

1. Determination of a specified holding period
2. Projected income/expenses over that period
3. Selection of an appropriate discount rate (the cost of a lost opportunity) 
4. Estimating present value based on that rate

Establishing ab Overall Capitalization Rate

The rate of return on the investment (Discount rate) | The rate of return of the investment (Recapture rate)

V (value of a property) = I (net operating income) / R (overall cap rate) | R = I / V | V x R = I

Methods to Determine Overall Cap Rate

1. Investor Analysis - the analysis of expected return of the investment and return on the investment.

ex. Property = $150000 | land allocation - 20% (30k) | building allocation - 80%

1. Establish return on Investment - the investor req. a 10% return.
2. Establish return of Investment - building economic life is 40 yrs, so funds invested should be returned over that time.
3. Recapture rate - Divide remaining economic life into 100%, which represents return of all investments (100 / 40 = 2.5%).
4. Overall Cap Rate - 20% land value at 10% - 0.2 x 0.1 = 0.02| 80% building value at 12.5% (10% + 2.5) 0.8 x 0.125 = 0.1 | 0.02 + 0.1 = 0.12 (12%)

Reconstructed Operating Statement - typically involves a 1 yr analysis of actual income and expenses according to the owner's statement for an investment property.

Income Multipliers - the relationship between the rent that can be obtained from a property and its selling price. The monthly rental factor (MRF) and the gross income multiplier (GIM) are used in the valuation of properties when the rents are known.

GIM (gross income multiplier) = Sale Price / Effective Gross Income

ex. The subject property's effective gross income = $50000. A comparable sale with an effective gross income of $56000 and a selling price $392000 is found. GIM = 392000 / 56000 = 7. The comparable sold for 7 times its effective income. This multiplier can be used with the subject property. V = 50000 x 7 = 350000.

MRF (monthly rental factor) - the ratio of value to the gross monthly rent. Ex. if the value is $60000 and the rent is $600, then: MRF = 60000 / 600 = 100. It demonstrates that the property sold for 100 times its monthly rent. The MRF is applicable if the monthly rent is known and an MRF can be determined from similar properties to the subject property. 

Provincial Land Transfer Tax - used when transferring property from one party to another.

Real Property Registration - tax is payable based on 3 conditions: a registration is made under either the Registry Act or Land Titles Act, the document being registered is a conveyance and the conveyance involves land.

First Time Buyers Refund - citizen or PR, 18+, the home is purchased for the first time. The refund is based on the amount of interest the individual owns in the newly constructed home. Buyers of the resale home may also be eligible to claim a refund up to $4k.

Municipal Land Transfer Tax - MLTT is charged on purchases in Toronto. Typically collected at the time of registration. First-time buyers of property which contains 1 and no more than 2 single-family residences are eligible for a rebate up to $4475.

 

Real Property Taxation

According to Value - the basis of the real property taxation is according to the value system. The current value = market value of the property. Tax depends on a % of the value of the property.

Tax Rate - the tax rate is established by dividing the projected annual budget by the tax base. Estimated Current Value x Tax Rate = Property Tax.

 

Closing Adjustments 

The Sale Transaction - commonly referred to as the date of completion. (when the buyer is to deliver the balance of money and seller is to deliver deed and vacant possession of the property). A closing statement (statement of adjustments) sets out the financial history of the transaction including all adjustments.

Adjustments:

1. Fuel - in the case of the tank, the seller fills the tank and the buyer pays for it.
2. Insurance - the buyer arranges new coverage and no adjustment is req. as per agreement.
3. Interest in Assumed Mortgages - interest due on the mortgage on the actual closing day is a responsibility of the buyer. 
4. Rent
5. Taxes/Local Improvements
6. Water/Utilities

Closing Costs - various expenses associated with the completion of a sale transaction.