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Ellwood technique

Discussion in 'Commercial/Industrial Appraisals' started by CANative, Dec 14, 2011.

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  1. CANative

    CANative Elite Member

    247
    Jun 18, 2003
    Professional Status:
    Certified Residential Appraiser
    State:
    California
    aka Mortgage Equity Technique.

    I understand the basics (The investment is typically not held forever - there is a "holding period" and that the investor receives the proceeds of the sale at the end of the holding period) but how does the "equity buildup" as the mortgage loan is paid down figure into the equations (models)?
     
  2. Pittsburgh Pete

    Pittsburgh Pete Elite Member

    68
    May 6, 2008
    Professional Status:
    Certified General Appraiser
    State:
    Pennsylvania
    the computation (it is a deduction from the constructed rate) is the loan ratio X paid off loan ratio (over the holding period) X the SFF at the equity yield rate for the holding period. This factors in a return on the increased equity amassed over the holding period.

    Does that answer your question?
     
  3. BRCJR

    BRCJR Senior Member

    12
    Sep 20, 2005
    Professional Status:
    Licensed Appraiser
    State:
    Virginia
    Is that also true if the property depreciates?
     
  4. CANative

    CANative Elite Member

    247
    Jun 18, 2003
    Professional Status:
    Certified Residential Appraiser
    State:
    California
    :)

    RO = YE - M(YE + P 1/SN - RM) - DO 1/Sn

    I feel like Abraham Lincoln trying to learn lawyer stuff by reading law books in front of the fireplace.
     
  5. Pittsburgh Pete

    Pittsburgh Pete Elite Member

    68
    May 6, 2008
    Professional Status:
    Certified General Appraiser
    State:
    Pennsylvania
    Not in this particular computation. However, there are additional computations that address increases/decreases in both property value and income.

    The formula I referenced only addressess increase in the equity and return on that increased equity--a situation that would happen even if the property's value is declining--at some point, however, the equity and the property value might cross paths.
     
  6. Ken B

    Ken B Elite Member

    110
    Feb 18, 2004
    Professional Status:
    Certified General Appraiser
    State:
    Florida

    I'm sorry, but could you put that in a bullet format?
     
  7. nstanbru

    nstanbru Member

    7
    Feb 19, 2009
    Professional Status:
    Certified General Appraiser
    State:
    California
    This might be a duplicate post, I was somehow logged off the site. Try to find a copy of "The Instant Mortgage Equity Technique" by Irvine E. Johnson. It was published for the SREA by Lexington Books/D.C. Heath and Company, 1972. I don't know if Mr. Johnson is still around, but he was located in Ventura, CA.
     
  8. CANative

    CANative Elite Member

    247
    Jun 18, 2003
    Professional Status:
    Certified Residential Appraiser
    State:
    California
    I schlogging my way through this... (It's more than I need to do what I do, but I want to learn more as I go along)

    Mortgage Equity Formula
    Mortgage financing creates both a mortgage (i.e., debt) and an equity interest in the property, and
    each of these interests can be analyzed and valued separately. The total value of a property is the
    sum of the values of these two financial components. Mortgage-equity analysis, broadly defined,
    refers to any income capitalization or investment analysis procedure that explicitly considers how
    mortgage terms and equity yield requirements affect the value of a property. Mortgage-equity
    analysis thus includes both the band of investment procedure for estimating a capitalization rate
    and discounted cash flow analysis when that technique is used to separately value cashflows to
    the equity interest.
    A well-known application of mortgage equity analysis is the use of the mortgage-equity (or
    Ellwood) formula for developing an overall capitalization rate. The Ellwood formula is similar in
    kind to the basic yield capitalization formula discussed earlier, but is different in two ways: first,
    it requires a given equity yield rate (YE) rather than an overall yield rate (YO); and second, it
    incorporates assumptions regarding the terms of financing (interest rate, length of loan, loan-tovalue
    ratio) in addition to those regarding an expected holding period and change in property
    income and/or value. Similar to the basic yield capitalization formula, the mortgage equity
    formula provides a direct method of solving for the present value of the property, given the set of
    assumptions described above, even though both the future value of the property (i.e., the
    property’s expected value at the end of the holding period) and the loan amount are based on the
    property’s present value. The basic mortgage-equity formula is as follows:
    RO = YE - M(YE + P 1/SN - RM) - DO 1/Sn
    where
    RO = overall capitalization rate
    YE = equity yield rate
    M = loan-to-value
    P = percentage of loan paid off
    1/Sn = sinking fund factor (SFF) at the equity yield rate
    RM = mortgage capitalization rate (mortgage constant)
    DO = percentage change in total property value over the holding period.
    The basic mortgage-equity formula can be used only with a level income stream. However, it can
    be modified to accommodate changes in income using income stabilization factors (so-called "J"
    and "K" factors). A series of tables containing solutions for many of the variables needed to solve
    the basic Ellwood formula and its refinements are also available, although these tables are now
    largely obsolete given programmable financial calculators and spreadsheet software.69
     
  9. Michael S

    Michael S Senior Member

    24
    Mar 18, 2009
    Professional Status:
    Certified General Appraiser
    State:
    New Mexico
  10. CANative

    CANative Elite Member

    247
    Jun 18, 2003
    Professional Status:
    Certified Residential Appraiser
    State:
    California
    Thanks for that link.
     
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