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Chapter 14. INCOME CAPITALIZATION: RATES AND TECHNIQUES. CHAPTER TERMS AND CONCEPTS. Direct capitalization technique Direct comparison method Discount rate Discounted cash flow (DCF) Equity dividend rate Equity residual technique Equity yield rate Going-in OAR Going-out OAR - PowerPoint PPT Presentation
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INCOME CAPITALIZATION: RATES AND TECHNIQUES
Chapter 14
Annuity recapture method
Band of investment method
Building residual technique
Capital recovery
Capitalization rate
Cash flow
Composite capitalization rate
Debt service
Delta (value change)
Direct capitalization technique
Direct comparison method
Discount rate
Discounted cash flow (DCF)
Equity dividend rate
Equity residual technique
Equity yield rate
Going-in OAR
Going-out OAR
Hypothecation
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CHAPTER TERMS AND CONCEPTS
Income stream
Interest rate
Internal rate of return
Investment value
Land residual technique
Leverage
Mortgage constant
Overall capitalization rate
(OAR)
Periodic rate
Ratio capitalization
Recapture rate
Reversion
Safe rate
Straight-line recapture method
Summation method
Time value of money
Yield capitalization
Yield rate
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CHAPTER TERMS AND CONCEPTS
LEARNING OUTCOMES
1. Define income capitalization.
2. List the three key characteristics of a future stream of income.
3. List the three methods used to derive or calculate interest and/or capitalization rates.
4. Define and illustrate direct capitalization.
5. Define discounted cash flow and describe its use in appraisals.
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INCOME CAPITALIZATION
Definition Income Capitalization Translates Income into its
Capital Equivalent
Income Characteristics Quality Quantity Duration
Three Aspects of Future Income
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INCOME CAPITALIZATION
Capitalization Recognizes the Time Value of Money Estimates the Present Worth of Future Benefits
A Capitalization Rate Provides A Return on Investment A Return of Investment
o Directly or indirectly
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COMPARING INVESTMENT PROPERTY
Investment Criteria
Safety – Burden of Taxes
Yield – Shelter from Taxes
Liquidity – Denomination
Management – Hypothecation
Appreciation – Leverage
Current and Future Return
Income stream
Cash flow
Reversion
Yield – vs. – Recapture
Yield = Return on investment capital
Recapture = Return of investment capital
Which Property Is the Safer Investment?
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RELATING ECONOMIC PRINCIPLES
Income Procedure Economic Principle
Project income for the property
Anticipation
Subtract operating expenses
Agents of Production
Allocate net income to land and buildings
Agents of Production; Contribution
Value land by the residual income attributed to land
Highest and best use; Contribution
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INCOME IS PRODUCTION
Relating Income Capitalization to Economic Principles
• Principle of Anticipation• Principle of Agents of Production• Principle of Contribution• Principle of Highest and Best Use
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SELECTION OF CAPITALIZATION RATE
Types of Rates Interest Rate
o Return ON capitolo Yield rateo Discount rate
Overall Rate (OAR)o Ratio between income and value
Recapture Rateo Return OF capitalo Recaptureo Amortization
Composite Capitalization Rate
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METHODS OF ESTIMATING RATES
Methods of Estimating RatesDirect comparisonBand of InvestmentSummation
oCapitalization
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PROVIDING CAPITAL RECOVERY
Straight-Line Method Assumes equal annual recapture from net income Used in several capitalization methods
Sinking Fund Method Assumes “safe rate” earnings Not commonly used in appraisals
Annuity (Inwood) Method Provides capital recovery in same way as loan
amortization Assumes recapture amounts earn interest Is referred to as yield capitalization
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CAPITALIZATION CHART
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THE BUILDING RESIDUAL TECHNIQUE
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THE EQUITY RESIDUAL TECHNIQUE
ESTIMATING, MEASURING, & DISCOUNTING CASH FLOWS
• The Use of Cash Flows in Appraisals• Estimating Cash Flows
• Measuring Cash Flow from Periodic Income• Even Cash Flow• Uneven Cash Flow• Income Projections
• Measuring Cash Flow from Sale Proceeds• Estimating the Future Sale Price
• Discounting Cash Flows
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Discount Formula
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SUMMARY
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Income capitalization is the process of translating income into value. By selecting capitalization rates that reflect the types andamounts of return sought in the real estate investment market, the appraiser completes the link between income and value.
The market value of amounts to be received in the future must always be reduced or discounted to their present values in some way to recognize the time value of money.
