14 Direct and Yield Capitalization Direct Capitalization Formula Net Operating Income Capitalization Rate = Value Categories of data needed for an appraisal using direct capitalization are Potential gross income Effective gross income Net operating income Capitalization rate

Net Operating Income Capitalization Rate = Value = V Net Operating Income Value Capitalization Rate _I_ V = = R

Building a Capitalization Rate Return of the investment, called capital recapture Return on the investment, called interest rate, discount rate, risk rate, or return on rate

Selecting the Rate for Capital Recapture Straight-line Method ______100%______ Years of Useful Life = Annual Recapture Rate

Selecting the Interest Rate Market Extraction Method Band of Investment Method Rate required by lender is mortgage constant Rate required by equity investor is equity capitalization rate, cash on cash rate, cash flow rate, or equity dividend rate

Relationship of Capitalization Rate and Risk High Capitalization Rate High Risk = = Low Value Low Capitalization Rate Low Risk = = High Value

Capitalization Techniques Using Residual Income Building Residual Technique can be used when appraiser knows value of the land Land Residual Technique can be used when appraiser knows value of the structures on the land Valuing Land and Building as a Whole

Yield Capitalization Real estate investment return is broken into: Income flow for specified number of years and 2. Capital change (gain or loss) realized at end of multiyear investment period from an actual or assumed sale of the property

Value of One Dollar Future value of $1 Future value of an annuity of $1 per year Sinking fund factor Present value of a $1 reversion Present value of an annuity of $1 per year Payment to amortize $1

Annuity Method of Capitalization Annuity is fixed return on investment Paid weekly, monthly, quarterly, or yearly Annuity factors table provides factor, based on interest rate and length of time of the investment, to be multiplied by desired level of yearly income to find present worth of the investment

Recapture Rates Under annuity method: Income stream remains constant Interest accrues each year on decreasing principal Recapture accounts for an increasing share of income each year

Recapture Rates Under straight-line method: Income decreases yearly by same amount Interest accrues each year on decreasing property value Recapture remains constant for each year