The Income Capitalization Approach

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After-tax cash flow

Back 1

Pre-tax cash flow minus income taxes

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Annuity

Back 2

regular & predictable payment stream

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Appreciation

Back 3

an increase in value or rental rates

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Built-up method

Back 4

adding components of a rate to indicate an overall yield rate

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Bundle of rights

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the concept that real property ownership may be represented by a bundle of sticks, with each stick representing a right of ownership if owned absolute. The appraiser values the bundle that is appropriate for the appraisal problem

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Business enterprise value

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value from intangibles such as marketing/management skill, trade names, patents, franchises, contracts, leases, etc.

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Capital recapture

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return "of", or getting the investment back to the investor

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Capitalization rate

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a relationship of some income divided by a value or sale price

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Cash flow rate

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the same as the equity capitalizaiton rate (equity cash flow divided by down payment)

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Contract rent

Back 10

the rent actually charged on a property

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Cost-push inflation

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an increase in price caused by increased costs of inputs

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Deflation

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a decrease in prices

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Demand-pull inflation

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an increase in prices caused by increased demand for a product or service

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Direct capitalization

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conversion of income to value in one step; generally, using a rate or multiplier into a single year income without specifying yield or pattern of income or value change

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Discount rate

Back 15

yield rate used to convert periodic income to value

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Discounted cash flow (DCF) analysis

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a valuation tool that expresses patterned cash flow discounted to a present value (minimum information: income, changes in income, reversion, discount rate); a yield capitalization method where anticipated future cash flows are discounted to PV

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Discounting

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the process of bringing a series of cash flows to present value by using a yield rate

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Effective gross income (EGI)

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PGI less vacancy & collection loss

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Equity capitalization rate (Re)

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Equity cash flow (NOI - DS) divided by down payment (Ve)

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Equity yield rate (Ye)

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yield to equity; the yield rate used to capitalize equity cash flow & equity reversion to PV

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Future benefits

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future cash flows that accrue to a position

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Going-concern value

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the value of a proven property operation. Includes real property, personal property, and intangibles

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Income capitalization rate

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any capitalization rate that expresses a relationship of some income to some corresponding value

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Income rate

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a rate expressing the relationship of a one year income stream to value; same as a capitalization rate

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Inflation

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a rise in prices due to a general price increase

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Interest rate

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a yield rate; usually the yield rate to the lender

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Internal rate of return (IRR)

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the rate (yield) that results in a net present value (NPV) = 0. The rate that satisfies PV of inflows to an investment minus the PV of investment = 0

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Investment value

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subjective value; value to a particular investor, or resulting from specific non-market supported assumptions of an indvidual or investor

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Leverage

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using borrowed capital to enhance return to equity

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Market rent

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the rent a property should command if available for lease in the open market

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Market value

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an objective value; a value that meets the definition requirements of a market value definition

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Net operating income (NOI)

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EGI minus expenses

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Non-realty interests

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personal property & intangibles

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Overall capitalization rate (Ro)

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NOI divided by value or sale price

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Overall yield rate (Yo)

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overall yield rate to property; the yield rate used to capitalize (discount) NOI and property reversion to the present value

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Partial interest

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an interest other than full ownership

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Potential gross income (PGI)

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all the income capable of being generated including rental and other or ancillary income

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Pre-tax cash flow

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NOI minus debt service (DS)

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Real estate

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land & all attachments (is physical, it can be seen)

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Real estate investment trust (REIT)

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pools funds of small investors to buy or lend in real estate; generally a trust organized in Massachusetts

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Real property

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the rights that come with owning real estate (cannot be seen physically)

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Recapture rate

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the rate that returns capital (return "of" investment) to the investor

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Residual techniques

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valuing a partial interest by dividing overall income into components, then capitalizing the income to the unknown component to derive value

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Return of capital

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recapture of the dollars put into an investment

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Return on capital

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return of interest on an investment

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Reversion

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a future value; the lump sum benefit received in the future

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Risk taking

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attempting to enhance return by investing in vehicles that have some uncertainty

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Safe rate

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a rate with little risk such as a rate on a U.S. government issued security

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Securitization

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converting ownership of real property interests in the form of securities or investment vehicles that issue securities

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Time value of money

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the concept that a $1 today is worth more than a $1 in the future, and the $1 in the future needs to be discounted to represent the value of a future $1

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Yield capitalization

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processing to value by either discounting or using a rate or mulitiplier that expresses the income & reversion over time in the derivation of the rate or multiplier

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Yield rate (Y)

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1) an interest rate, discount rate, internal rate of return; the return over the life of the investment, as opposed to a one year return. 2) Often used to refer to the equity return over the life of the investment

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Appraisal principles

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1. Anticipation
2. S & D
3. Sustitution
4. Balance
5. Externalities