INCOME CAPITALIZATION: RATES AND TECHNIQUES

1. Chapter 14 INCOME CAPITALIZATION: RATES AND TECHNIQUES

2. 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 • Hypothecation • Annuity recapture method • Band of investment method • Building residual technique • Capital recovery • Capitalization rate • Cash flow • Composite capitalization rate • Debt service • Delta (value change)

3. CHAPTER TERMS AND CONCEPTS • Periodic rate • Ratio capitalization • Recapture rate • Reversion • Safe rate • Straight-line recapture method • Summation method • Time value of money • Yield capitalization • Yield rate • Income stream • Interest rate • Internal rate of return • Investment value • Land residual technique • Leverage • Mortgage constant • Overall capitalization rate • (OAR)

4. LEARNING OUTCOMES Define income capitalization. List the three key characteristics of a future stream of income. List the three methods used to derive or calculate interest and/or capitalization rates. Define and illustrate direct capitalization. Define discounted cash flow and describe its use in appraisals.

5. INCOME CAPITALIZATION • Definition • Income Capitalization Translates Income into its Capital Equivalent • Income Characteristics • Quality • Quantity • Duration

6. Three Aspects of Future Income

7. 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 • Directly or indirectly

8. 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

9. Which Property Is the Safer Investment? 1 2

10. RELATING ECONOMIC PRINCIPLES

11. INCOME IS PRODUCTION

12. Relating Income Capitalization to Economic Principles • Principle of Anticipation • Principle of Agents of Production • Principle of Contribution • Principle of Highest and Best Use

13. SELECTION OF CAPITALIZATION RATE • Types of Rates • Interest Rate • Return ON capitol • Yield rate • Discount rate • Overall Rate (OAR) • Ratio between income and value • Recapture Rate • Return OF capital • Recapture • Amortization • Composite Capitalization Rate

14. METHODS OF ESTIMATING RATES • Methods of Estimating Rates • Direct comparison • Band of Investment • Summation • Capitalization

15. 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

16. CAPITALIZATION CHART

17. THE BUILDING RESIDUAL TECHNIQUE

18. THE EQUITY RESIDUAL TECHNIQUE

19. 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

20. Discount Formula

21. SUMMARY Income capitalization is the process of translating income into value. By selecting capitalization rates that reflect the types and amounts 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.