Incorporating property value increases into project metrics.

[Tyson Taylor]

Hello BP,

This is my first time asking a question, so apologies if I screw it up. 

My question is how you folks incorporate property value increases into project metrics. I've seen the models that put a normal 2-3% property value appreciation into ROI, which makes sense. What I'm looking at though is in a development/rehab scenario where at the end of the project you'll have added a significant amount of value, more like 25-50%.

For example, I buy a property for 100k, and put 150k into it. Assume it was the right place/right time and now the property is worth $500k. I guess I should also ask, does anyone else use a CAP rate calc to determine value? I assume I can sell a 7 or 8% CAP, so if I have an NOI of $36k annually, I estimate value at around $500k.

So if I were wanting to display the project economics to someone, say a hard-money lender or bank, how would the increase in property value be shown? If I calculate the IRR without property appreciation, it's not that great (around 9%). If I add back the increase in property value into the first year of revenue then the IRR goes up to a respectable 27%.

To add another layer of confusion...what if the bulk of the initial investment is borrowed money? Say I put in $50k of my own cash, the rest was borrowed and at the end of development/beginning of revenue I have a note for $200k that's costing me $15k a year. This is a NNN lease so my annual opex is almost nil. Obviously now my IRR is obscenely high and I don't want to put numbers in front of people that look absurd.

Any advice is greatly appreciated!