Part 1 Introduction to the Income Capitalization Approach Flashcards
What is the Economic Principle for: The perception that value is created by the expectation of benefits to be derived in the future.
Anticipation
What are examples of the Economic Principle: Anticipation
Projected market and contract rents
Converting income into value
What Economic Principle is: The principle that economies outside a property have a positive effect on its value while diseconomies outside a property have a negative effect on its value.
Externalities
What Economic Principle is: The result of the cause and effect relationship among the forces that influence real property value.
Change
What examples are for the Economic Principle: Externalities:
Market rents
Vacancy rates
Market expenses
Converting income into value
What examples are of the Economic Principle: Change
Vacancy rates
Converting income into value
What Economic Principle is: The appraisal principle that states that when several similar or commensurate commodities, goods, or services are available, the one with the lowest price will attract the greatest demand and widest distribution. This is the primary principle upon which the cost and sales comparison approaches are based.
Substitution
Examples of the Economic Principle: Substitution
Market rents
Market expenses
Converting income to value
What Economic Principle is: The concept that the value of a particular component is measured in terms of the amount it adds to the value of the whole property or as the amount that its absence would detract from the value of the whole.
Contribution
What Economic Principle examples are for Contribution:
Land and building to the whole
What Economic Principle is: The price of real property varies directly, but not necessarily proportionately, with demand and inversely, but not necessarily proportionately, with supply.
Supply and demand (as it relates to real estate)
What are the examples of the Economic Principle: Supply and Demand (as it relates to real estate)
Market rents
Vacancy rates
Market expenses
Converting income to value
What Is Capitalization?
Capitalization is the conversion of income into value.
What is Capitalization rate
Used to convert a single year’s income into value.
Also called cap rates, all capitalization rates are abbreviated with the
letter R, and that’s the only concept where we will use the letter R.
What is Multiplier
Used to convert a single year’s income into value.
Sometimes called a factor, and often abbreviated with the letter F or the letter M, a multiplier is the ratio between the sale price (or value) of a property and its potential gross income, its effective gross income, or infrequently, its net income.
A capitalization rate is calculated with value or sale price in the denominator, and a multiplier has value or sale price in the numerator, but they both convert a single year’s income into value.
The two general methods of capitalization are xx x xx
direct and yield.
Direct capitalization
A method used to convert an estimate of a single year’s income expectancy into an indication of value in one direct step, either by dividing the net income estimate by an appropriate capitalization rate or by multiplying the income estimate by an appropriate factor. Direct capitalization employs capitalization rates and multipliers extracted or developed from market data. Only one year’s income is used. Yield and value change are implied, but not explicitly identified
The general direct capitalization formula that uses a capitalization rate is
I/R=V
where I is income and V is value.
Variables below the horizontal line (rate and value) are multiplied together to get the variable above the horizontal line (income), or a variable
below the line (e.g., rate) should be divided into the upper variable (i.e., income) to achieve the remaining variable (value). This formula and its reconfigurations when solved for R or I, are often referred to as “IRV.”
1.2 Example—Potential Gross Income Multiplier: What is the value of a property with a $100,000 potential gross income and a potential gross income multiplier (PGIM) of 4.0?
V=I×M
= $100, 000 × 4.0 = $400,000
x x also has two related applications, both involving multiple years’ income.
Yield capitalization
(A method used to convert future benefits into present value by
1) discounting each future benefit at an appropriate yield rate or
2) developing an overall rate that explicitly reflects the investments income pattern, holding period, value change, and yield rate.)
A method used to convert an estimate of a single year’s income expectancy into an indication of value in one direct step, either by dividing the net income estimate by an appropriate capitalization rate or by multiplying the income estimate by an appropriate factor.
Direct capitalization
A rate used to convert income into value.
Capitalization rate
A method used to convert future benefits into present value by (1) discounting each future benefit at an appropriate yield rate, or (2) developing an overall rate that explicitly reflects the investment’s income pattern, holding period, value change, and yield rate.
Yield capitalization
Capitalization
The conversion of income into value.
The perception that value is created by the expectation of benefits to be derived in the future.
Anticipation
What symbols are used for the following?
Yield rate
Value
Income
Capitalization rate
Yield rate Y
Value V
Income I
Capitalization rate R
A small retail property has a net operating income of $250,000 and the appropriate capitalization rate is 8%.
a. Should direct or yield capitalization be used to solve this problem?
b. What formula or drawing should be used in this problem?
e. What is the value of the property?
a. Direct capitalization
b. I/R = V
e. 250000 enter
0.08/
= 3,125,000
