CAPITALIZATION OF RENTS

 

The method of capitalization of rents is used by law at the moment in the valuation of the nonurbanizable ground and some urbanizable land, of subsidiary way, when the use of the comparison method is not possible.

The Project of Law of Suelo anticipates its use for the valuation of the rural ground.

Nevertheless, independently of its application by law, the method of capitalization of rents is valid for the adoption of other decisions in the scope of the real estate investment. For example:


- You have got a building and you are thinking about selling it or renting it. Without considering the effort of management and risk, taking care of solely the current of awaited income. What is better for you? Is worth the trouble and risks implied in a renting contract?

- You don't know what to do, you have a lot of doubts about it and you are thinking in acquiring a building or to renting it. It is the same problem, but from the optical of renter/buyer. What to do?

In order to simplify calculations the following assumptions are made:

- The RENT AMOUNT, if the calculations are made by the landlord, will be considered in its net amount, deduced the taxes and periodic expenses of conservation and maintenance. If the calculations are made by the renter, it considers his gross amount, taxes and any other periodic cost including. In both cases, a constant, actualizable based on the rate of inflation, also constant periodic rent will be considered annually. In order to simplify the compute of actual value, the formula corresponding to a perpetual rent will be applied, as if the building lasted indefinite. The amount of the rent can be introduced by surface unit (m2), or the total amount of the considered building, whenever the same unit in the value of purchase is used, in order to use homogenous units.

- The VALUE OF PURCHASE will include all the expenses and applicable taxes. If It's the SALE value, expenses and taxes wil be discounted. Units must be homogenous, use the same unit as to express the rent amount.

- The INTEREST RATE used to compute actual value must be chosen next to the risk free interest rate. It is advised to use the EURIBOR to a year. If the comparison is made from the point of view of the potential buyer, must be chosen, at least, between 0'33 and 0'8 points higher, since it will not obtain an inferior cost of financing by means of mortgage. If the comparison makes a potential seller, must choose an interest rate very next to the EURIBOR or slightly inferior, since it does not have guarantees of being able to obtain a greater yield, without risk, for the product of the sale. We use a constant rate (unreal assumption to simplify the calculations). The program of valuation and comparison corrects the interest rate of update with the two following parameters.

- The RATE OF INFLATION assumes constant and increases the rents annually. The rate of update, like real interest, would be the difference between the chosen interest rate and inflation rate. At the most elevated it is the inflation the greater will be the present value from the capitalization of rents.

- The RATE OF REVALUATION OF the BUILDING, is the annual rate average to which it is expected increases the value of real estate. It affects the capitalization rate with the same sign that inflation rate.

Introducing the data in the boxes that follow. Repercussion can be appraised by the modification of each one of the factors that take part in the capitalization of rents.

SALE PRICE OF THE BUILDING : DOLLARS

MONTHLY RENT BY RENT OF THE BUILDING: DOLLARS

AVERAGE ANNUAL RISK FREE INTEREST RATE (CAPITALIZATION RATE):

AVERAGE ANNUAL INFLATION RATE:

AVERAGE ANNUAL REAL-ESTATE PRICES INCREASE RATE:

NUMBER OF YEARS FOR COMPARATION:



FINAL VALUE OF THE RENTS: DOLLARS

CAPITAL INCREMENTS: EUROS (FINANCE COSTS INCLUDED)

IF YOU ARE A POTENTIAL SELLER, YOU MUST PREFER:

- REPEATS THE CALCULATION WITH OTHER VALUES. Consider the possibility that the buildings are revalued to a rate superior to the one of inflation. Consider a scene with an interest 1'5 or 2 points over the EURIBOR.

- USE other simple caculator as the one in "FORBES: Rent versus sell house" and compare results.

- DON'T FORGET THAT THIS ONE IS an APPROACH, although is helpful for making a decision of purchase or sale as opposed to rent.

- If as a POTENTIAL RENTER INTERESTS TO BUY, as POTENTIAL SALESMAN INTERESTS TO RENT (safe from risk, guarantees and management).

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