Welcome to the
International Right of Way
Association’s
Course 402
Introduction to the Income
Capitalization Approach
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402PPT.R3.2014.01.21.0.0
Introductions
Who we are…
What we do…
Where we do it…
How long we’ve been doing it…
Our goals for the day...
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Objectives (1)
At the conclusion of the day,
you will be able to...
• Express an understanding of the
valuation process and the income
capitalization approach
• Appreciate the differences between
direct and yield capitalization
3
Objectives (2)
At the conclusion of the day,
you will be able to...
• Apply the income capitalization
approach (direct capitalization)
to specific valuation situations
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Housekeeping
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Schedule
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8:00 - 8:30
Introductions, Etc.
8:30 - 9:00
Valuation Process
9:00 - 9:30
Income Capitalization Approach
9:30 - 10:00
Direct and Yield Capitalization
10:15 - 3:00
Components of Direct Capitalization
3:00 - 3:45
“After Value” and Compensation
3:45 - 4:00
Summary and Review
4:00 - 5:00
Exam
Valuation Process
Appraisal Problem Definition
Scope of Work
Data Collection/Selection/Analysis
Land Value Opinion
Three Approaches to Value
Reconciliation and
Final Value Opinion
Defined Value Opinion Report
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Highest and Best Use
The reasonably probable and legal use that is
physically possible, appropriately supported,
and financially feasible, and that results
in the highest value.
• Physically possible?
• Legally permissible?
• Financially feasible?
• Maximally productive?
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Three Approaches to Value
Cost Approach
Sales Comparison
Income Capitalization Approach
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Cost Approach
• Develop a value opinion for the land
• Estimate the cost new of the improvement
• Deduct depreciation
• Add land value opinion to the depreciated
improvement value
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Sales Comparison Approach
• Research the market for comparable data
• Develop relevant units of comparison
• Compare the sales to the subject and
adjust for dissimilarities
• Reconcile the value indications into
a final value opinion
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Income Capitalization Approach
In developing a property value opinion by the income
capitalization approach, the appraiser converts income
into value through the application of a rate or a ratio.
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Valuation Process
Appraisal Problem Definition
Scope of Work
Data Collection/Selection/Analysis
Land Value Opinion
Three Approaches to Value
Reconciliation and
Final Value Opinion
Defined Value Opinion Report
13
Income Capitalization Approach
In developing a property (market) value opinion by the
income capitalization approach, the appraiser converts
(net operating) income into (market) value through the
application of a (overall capitalization or yield) rate or
ratio (multiplier).
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Formulas
Value = Net operating income  Capitalization rate
V=IR
Net operating income = Capitalization rate x Value
I=RxV
Capitalization rate = Net operating income  Value
R=IV
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Example
Value = Net operating income  Capitalization rate
V=IR
V = $75,000  .105
V = $714,286
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Exercise No. 1
Value = Net operating income  Capitalization rate
V=IR
V = $48,000  .12
V = $400,000
Capitalization rate = Net operating income  Value
R=IV
R = $33,000  $300,000
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R = .11
Direct/Yield (1)
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Income Capitalization Approach
• Estimate the subject’s potential gross income
• Determine a vacancy and collection loss
• Subtract the vacancy and collection loss from the
potential gross income
• Estimate annual operating expenses and subtract the
expenses from the effective gross income to arrive
at the net operating income
• Develop a capitalization rate
• Convert the net operating income into value
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Case Study(1)
PGI =
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$43,375
Case Study(2)
PGI =
V&C =
EGI =
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$43,375
- 4,338
$39,037
Expenses
Fixed
Variable
Replacement allowances
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Case Study(3)
PGI
= $43,375
V&C
= - 4,338
EGI
= $39,037
Expenses = - 16,025
NOI
= $ 23,012
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Band of Investment
Ro = (M x RM) + (E x RE)
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Market
Ro = I  V
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Case Study(4)
Ro = (M x RM) + (M x RM) + (E x RE)
Ro = (.70 x .1096) + (.15 x .1699) + (.15 x .16)
Ro = .1262 or 12.62%
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Case Study(5)
Sale No. 1: Ro = I  V or Ro = $25,870  $205,000 or 12.62%
Sale No. 2: Ro = I  V or Ro = $22,085  $175,000 or 12.62%
Sale No. 3: Ro = I  V or Ro = $22,527  $178,500 or 12.62%
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Case Study(6)
PGI
= $43,375
V&C
= - 4,338
EGI
= $39,037
Expenses = - 16,025
NOI
= $ 23,012
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$ 23,012  .1262 = $182,345
Case Study(7)
PGI
= $41,875
V&C
= - 6,281
EGI
= $35,594
Expenses = - 15,540
NOI
= $ 20,054
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$ 20,054  .1262 = $158,906
Case Study(8)
Before value = $182,345
After value
= $158,906
Compensation = $ 23,439
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Objectives (1)
Now, you are able to...
• Express an understanding of the
valuation process and the income
capitalization approach
• Appreciate the differences between
direct and yield capitalization
34
Objectives (2)
Now, you are able to...
• Apply the income capitalization
approach (direct capitalization)
to specific valuation situations
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Thank you!
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402PPT.R3.2014.01.21.0.0