1. Kenneth L. Joyner, RES, AAS
Direct Capitalization: Proper Development in the Income Approach to Valuation
Kenneth L. Joyner, RES, AAS

2. Presentation Goals What is the Direct Capitalization Method
When the Direct Capitalization Method would be the most reliable method of valuing income producing properties
A Basic Understanding of the 3 Components of the Direct Capitalization Method
How Market Value is Computed When Valuing Property Using the Direct Capitalization Method

3. Direct Capitalization Defined
A method used to convert an estimate of a single year’s income expectancy into an indication of value in one direct step (i.)
i. The Dictionary of Real Estate Appraisal, Fourth Edition, Appraisal Institute

4. Direct Capitalization
When to use Direct Capitalization
It is most reliable when you have comparable sales with income stream with the same characteristics of risk, timing, stability, financing, and income projections as your subject

5. Basic Components of the Direct Capitalization Method
Net Operating Income
Capitalization Rate
Market Value
Formula
Net Operating Income / Capitalization Rate
=Market Value

7. Income Estimation Net Operating Income How Do We Get There
Reconstruct the Income Statement
Go to the Market (Looking for the TYPICAL)
Market Rent
Market Vacancy/Collection Levels
Market Expense Levels (Average One Year Expense Level)

8. Income(s) Estimation Different Levels of Income
Potential Gross Income=(Market Rent X Total Leaseable Area)
Effective Gross Income=PGI-Vacancy & Collection Loss + Miscellaneous Income
Net Operating Income=EGI-Operating Expenses & Replacement Reserves

9. Steps to Income Estimation
1. Potential Gross Income
- Vacancy and Collection Loss
+ Miscellaneous Income
Effective Gross Income
- Operating Expenses
Net Operating Income

10. Basic Components of the Direct Capitalization Method
Net Operating Income
Capitalization Rate
Market Value
Formula
Net Operating Income / Capitalization Rate
=Market Value

12. Capitalization Rate Definition
Any rate used to convert an estimate of income to an estimate of market value (ii.)
Reflects the ratio of income to value
Example
A 10% cap rate means that net operating income is equal to 10% of the market value of the property
ii. Property Appraisal and Assessment Administration, IAAO, 1997.

13. Capitalization Rates
The capitalization rate (this typical relationship between income and value) is based on market information/data
Includes typical buyer/seller expectations and requirements from the market
When computing for ad valorem purposes it should include a component for property taxes (effective tax rate)

14. Capitalization Rates Effective Tax Rate
In North Carolina since the level of assessment is 100% of market value, effective tax rate and the approved tax rates in each jurisdiction are the SAME
Included as a part of the capitalization rate only when determining value for ad valorem purposes

15. Capitalization Rates Effective Tax Rate (Cont.)
To deduct the property taxes paid as an expense in determining the NOI would presuppose correctness in the value that the bill is based on
We include the ETR as a part of the overall capitalization rate to avoid bias in the final estimate of value for property taxes

16. Basic Components of the Direct Capitalization Method
Net Operating Income
Capitalization Rate
Market Value
Formula
Net Operating Income / Capitalization Rate
=Market Value

18. Definition of Market Value
The most probable price, as of a specified date, in cash, or in terms equivalent to cash, or in other precisely revealed terms, for which the specified property rights should sell after reasonable exposure in a competitive market under all conditions requisite to a fair sale, with the buyer and seller each acting prudently, knowledgeably, and for self-interest, and assuming that neither is under undue duress (iii.)
iii. The Dictionary of Real Estate Appraisal, Fourth Edition, Appraisal Institute

19. Definition of Market Value
NCGS defines market value as “the price estimated in terms of money at which the property would change hands between a willing and financially able buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of all the uses to which the property is adapted and for which it is capable of being used”

20. Basic Components of the Direct Capitalization Method
Net Operating Income
Capitalization Rate
Market Value
Formula
Net Operating Income / Capitalization Rate
=Market Value

22. Computing Value How to apply Ex. $100,000/.1=$1,000,000 Formula
NOI/Cap Rate=Market Value
Ex. $100,000/.1=$1,000,000

23. Computing Value

24. Computing Value
(cont.)

25. Presentation Goals What is the Direct Capitalization Method
When the Direct Capitalization Method would be the most reliable method of valuing income producing properties
A Basic Understanding of the 3 Components of the Direct Capitalization Method
How Market Value is Computed When Valuing Property Using the Direct Capitalization Method