Question 1

What is the yield capitalization method in real estate appraisal?

Accepted Answer

Yield capitalization (also called discounted cash flow analysis): an appraisal method that converts a series of future income streams and a reversion (sale price at the end of the holding period) into a present value using a discount rate. Unlike direct capitalization (which divides a single year’s NOI by a cap rate): yield capitalization accounts for: changes in income over time, lease rollovers and vacancy, capital expenditures, and the expected sale price at the end of the holding period. The method: is used for complex income-producing properties where: income is expected to change significantly over time.

Question 2

How does yield capitalization work?

Accepted Answer

Process: project future cash flows (estimate: gross income, vacancy, operating expenses, and NOI for each year of the holding period: typically 5-10 years), estimate the reversion (the expected sale price at the end of the holding period: typically estimated by: applying a terminal cap rate to the final year’s NOI), select a discount rate (the yield rate: the rate of return required by investors for: the property type and risk level: typically 7-12% for commercial RE), and discount to present value (each year’s cash flow and the reversion are: discounted back to the present using the discount rate: PV = CF / (1+r)^n). The sum of all present values: equals the property’s estimated market value.

Question 3

When is yield capitalization preferred over direct capitalization?

Accepted Answer

Preferred when: income changes (the property’s income is expected to: change significantly over the holding period: lease expirations, rent escalations, or vacancy), complex properties (the property has: multiple tenants with different lease terms, significant capital expenditure needs, or unusual income patterns), investment analysis (the client needs: a detailed analysis of investment returns: IRR, NPV, and cash-on-cash return), and institutional properties (institutional investors and lenders: typically require DCF analysis for: large commercial properties). Direct capitalization: is preferred when: income is stable and predictable.

Yield Capitalization Method: Appraisal

Yield Capitalization Method (Appraisal)

What It Is

Process

When Preferred

Related Terms

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