Instructor’s Manual: Basic Real Estate Appraisal, 8th. Edition
Chapter 14
CHAPTER 14
INCOME CAPITALIZATION: RATES AND TECHNIQUES
STUDENT LEARNING OUTCOMES
This chapter completes the income approach. Here are the topics to cover:
14.1
14.2
14.3
14.4
Purpose and Theory of Capitalization
Selection of the Capitalization Rate
Direct and Residual Capitalization Techniques
Estimating, Measuring, and Discounting Cash Flows
Class Activities
[Instructor: Complete as needed.]
Lecture [ ] Discussion [ ] Breakout Groups [ ] Other _____________[ ]
14.1 PURPOSE AND THEORY OF CAPITALIZATION
Capitalization is a method of valuing income property. Techniques available depend upon:
1) the nature of the appraisal problem, and 2) the kind of data available. Commonly used techniques are
described in Section 14.3.
Capitalization Defined
Capitalization is a process of converting income into its capital equivalent.
1. Capitalization focuses on the present worth of future benefits.
2. It discounts future income to recognize the time value of money. Discounting is explained in
Section 14.4.
3. It is an analysis of the quantity, quality, and duration of the future income to be produced by an
investment.
Capitalization Rate Defined
A capitalization rate is generally defined as any rate used to convert income into its value equivalent.
There are different types of capitalization rates and capitalization techniques.
 It directly or indirectly provides for both a return on and return of the money invested.
 Types of rates are discussed in Section 14.2.
 The most common capitalization rate is the overall capitalization rate, overall rate, or OAR,
calculated by dividing a property’s net operating income by its sale price.
 Capitalization techniques are divided into two families: ratio capitalization and yield capitalization,
to be explored further.
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Instructor’s Manual: Basic Real Estate Appraisal, 8th. Edition
Chapter 14
Comparing Investment Property
1.
Real estate competes for the use of capital with other types of investments.
2.
Investment criteria include the following:
Safety
Yield
Liquidity
Freedom from Management Burden
Prospects for Appreciation
Burden of Property Taxes
Shelter from Income Taxes
Size or Denomination
Hypothecation
Leverage
[Instructor: We have come to believe that students really need to understand these criteria, in
order to estimate the needed returns for a particular property!]
Current and Future Returns
1.
Current returns:
a.
The current return is the net operating earnings, often called the income stream.
b.
The current income after loan payments (debt service) is called equity cash flow or the
equity dividend.
2.
Future or “deferred” returns:
a.
The funds available when an investment is sold; the reversion.
b.
Such returns may include amounts from loan pay-off (equity buildup), as well as from
property appreciation in value. [see Example 14-2 in text]
3. Returns may be calculated on either:
a.
A property or equity basis (if a loan is involved)
b.
A “pretax” or “post-tax” basis (i.e. income tax effects)
Yield versus Recapture
1.
Yield is the return on invested capital; but can be from a combination of income stream and future
capital gain.
2.
Recapture is the return of the invested capital; capital recovery.




In finance, the loan is the investment; recapture is usually provided for in the principal
portion of monthly or annual loan payments on an amortized loan.
In the investor’s mind, recapture of a real estate investment is less clear. It can come from
- The annual net operating income
- Proceeds of future sale
- A combination of the two - yield-to-maturity and internal rate of return
In yield capitalization techniques, recapture must be specified, but in ratio capitalization,
recapture occurs in an unspecified manner.
Investment recapture (recovery) in appraisals will be covered in the next section.
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Instructor’s Manual: Basic Real Estate Appraisal, 8th. Edition
Chapter 14
Relating Income Capitalization to Economic Principles
Specific economic principles underlay income capitalization. (See Chapter 5.)
Principle of Anticipation
Income capitalization discounts the anticipated future income to its present capital worth.
Principle of Agents of Production
Labor, coordination, capital, and land are paid out of income, in the form of (1) operating expenses first,
and then (2) the remaining net income attributed to land and improvements.
Principle of Contribution
Selected portions of the property (e.g., the land, the building, or the equity investment) are valued by
capitalizing the net income they contribute. Relates to specific residual capitalization techniques.
Principle of Highest and Best Use
Land is valued by the income it can contribute when in its highest and best use (i.e greatest return to
land).
14.2 SELECTION OF THE CAPITALIZATION RATE
 The capitalization rate is the connecting link between income and value.
 Selecting the appropriate rate is a critical part of the income approach.
Distinct Types of Rates
The four distinct types of rates used in appraisals are listed and defined here.
Interest Rate
Rate of return on invested capital; synonymous with yield rate and discount rate, it does not include any
recapture of investment capital.
Overall Capitalization Rate (“Cap Rate”)
The “OAR” is the relationship between net income and value. Both return on investment and recapture of
investment capital are hidden within it.
Recapture Rate
The rate at which invested funds are being returned to the investor. Rarely used today in practice.
Composite Capitalization Rate
A rate providing for both interest and recapture, in separately selected amounts and known proportions.
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Chapter 14
The Relationship of Yield and Overall Rates
If an income-producing property is expected to have increasing income and value in the future, some of
the return on investment will come from the reversion. Here, the overall capitalization rate (R) would be
less than the interest rate (Y).
When the property value is expected to decline, some return or recapture must come from income,
because the reversion will be too small. Therefore, the overall rate (R) would be more than the interest
rate, because it has to include a recapture component.
The link between the overall capitalization rate and the interest rate is the expected future change in value,
labeled delta (Δ – Greek letter).
If an income-producing property is expected to have a level net income and value for many years,
recapture will come from resale and yield from the income. Therefore, the interest rate or yield (Y) will
be the same as the overall capitalization rate.
Delta is the annual equivalent of the expected future value change. If value is expected to go down a
steady 1% per year, then delta is a plus 1%. If value is expected to double in two years when a new lease
is signed and then go up at 2% per year, the value change must be converted to its annual equivalent,
using techniques studied in advanced capitalization classes. Another alternative is to estimate each future
year’s income and value as a cash flow, discussed in Section 14.4.
Methods of Estimating Rates
The Direct Comparison Method
This is generally the preferred method of deriving a capitalization rate.
Analyze each comparable sale, and divide the net income (I) by the sales price (V) (after adjusting for
non-market financing). The result is the indicated overall cap rate (OAR or Ro).
Example:
Net operating income (Io)
Divided by: Selling price (Vo)
Equals: Overall rate (Ro)
In percent
$ 80,000
÷ $800,000
0.10
10%
The data obtained from sales can be made stronger by studying published surveys of OARs, or by
interviewing active brokers and investors regarding OARs and the issues that affect them.
The direct comparison method can also be used to estimate the equity dividend rate (Re).
Net operating income (Io)
Less: Annual debt service (Im)
Equals: Equity cash flow (Ie)
Divided by: Equity investment (Ve)
Equals: Equity overall cap rate (Re)
In percent
14-4
$80,000
- 73,440
$6,560
÷ 160,000
0.041
4.1%
Instructor’s Manual: Basic Real Estate Appraisal, 8th. Edition
Chapter 14
[Instructor: We have started to introduce the standard capitalization labels in this edition. We
also recommend stressing to the students how many terms, such as Re, have a number of different
names and symbols on the street!]
To extract the property interest rate rather than the overall rate, deduct the delta from the OAR, whereby
Yo – Ro = Δ.
The less-reliable classic analysis can also be used. Deduct any required annual recapture from the net
operating income, to get the annual interest income. Divide by the sale price to get the annual interest
rate. This is most valid when 1) land value is not changing, and 2) improvement contribution to value is
expected to slowly decline.
[Instructor: See text Example 14.3 to demonstrate this method.]
The Band of Investment Method
This method produces a weighted average rate, combining rates for mortgage loan money and for equity.
There are two separate versions of this method.
1.
Use the prevailing mortgage interest rate and the yield rate for equity. An example from your text
follows (Example 14-4). Note that good evidence of equity yield rates is hard to find:
Example 14-4:
Assume a 75% loan at 9%, and a 12% yield on equity investment.
Loan
Plus: Equity
Equals: Property interest rate
In percent
2.
0.75 x 0.09
0.25 x 0.12
=
=
0.0675
+ 0.0300
0.0975
9.75%
Alternatively, use the mortgage constant instead of the loan interest rate, and the equity cash-oncash (dividend) rate instead of the equity yield rate.
a.
b.
The mortgage constant is the ratio of the annual loan payment to the loan amount, that is,
the payment divided by the loan, or the overall rate for the mortgage (Rm).
Here, the rate for equity is the ratio of so-called “cash flow” to the equity investment.
Here is an example from your text (Example 14-5):
Example 14-5:
Assume that an 80% loan pays off at a constant 8% per year and the buyer requires a 7%
first-year cash flow on the down payment.
Loan
0.80 x 0.08 =
Plus: Equity
0.20 x 0.07 =
Equals: Indicated overall rate (Ro)
In percent
14-5
0.64
+ 0.014
0.078
7.8%
Instructor’s Manual: Basic Real Estate Appraisal, 8th. Edition
Chapter 14
The Summation Method
This method rates the property by various investment criteria. The return on a risk-free investment, such
as a government bond, is used for the safe rate. Other rates are added to it. In practice, this is rarely used,
as the amounts to be added are very difficult to justify. Sometimes called a built-up rate.
Here is an example from your text:
Example:
Safe rate
Plus: Investment Risk
Plus: Lack of liquidity
Plus: Burden of management
Equals: Indicated interest rate
6.75%
+ 3.00%
+ 1.25%
+ 1.00%
12.00%
Other Methods of Calculating Rates
1.
Add a recapture component to an interest rate (as derived above). The result is a composite rate.
2.
Add a component for anticipated future value change and/or capital recovery. This converts an
interest rate into an overall rate.
3.
Use the Ellwood method. This provides a weighted-average loan and equity OAR that adjusts for
mortgage pay-off and property appreciation. However, financial calculators, spreadsheets, or
income projection programs are usually used to make these analyses.
Adjusting Rates to Apply to the Subject Property
Capitalization rates from comparable sales may need adjusting for differences in physical characteristics
and economic conditions. Consider adjusting rates for the following factors:
1.
Property location
2.
The age, quality, and condition of any improvements
3.
The remaining economic life of the improvements
4.
The ratio of building value to total value
5.
Expenses that need to be reflected as a percentage of market value (e.g., ad valorem
property taxes)
How to Allow for Capital Recovery
In some capitalization methods, the appraiser must explicitly consider capital recovery. None are
commonly used today!
The three recognized methods of estimating an explicit amount of capital recovery follow.
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Chapter 14
Straight-Line Recapture
Assumes that equal annual recapture payments are provided out of the annual net income, in one of two
ways:
1.
The recapture is treated as an expense in dollars or,
2.
It is made a component of the capitalization rate.
While not recommended today, several capitalization techniques make use of this method. More about
straight line recapture later.
The Sinking Fund or Hoskold Method
Assumes that annual recapture amounts are deposited into a sinking fund account, where they earn
compound interest at a “safe rate.” The method is rarely used by appraisers today. A similar concept is
used by portfolio managers to analyze returns of the entire portfolio – the modified internal rate of return.
The Annuity or Inwood Method
Provides capital recovery out of level annual income, in exactly the same manner that a loan is paid off.
 Annual recapture amounts are assumed capable of earning compound interest at the yield or interest
rate of the property.
 A given amount of income recaptures a larger investment than in the straight-line method.
The annuity or “yield capitalization” method is suitable for any type of property, if the yield rate is
adjusted to reflect the risk involved.
[Instructor: Yield capitalization techniques are discussed in Section 14.3.)
The Recapture Time Period
The period of recovery (recapture) of investor capital could depend upon:




The investor’s holding period or other option
The estimated remaining economic life of the improvements
The age and condition of the improvements
The risk of building obsolescence
The Mechanics of Straight-Line Recapture
Straight-line recapture uses either a composite building capitalization rate to value the improvements, or a
calculated overall rate to value the total property. The steps in calculating a composite rate for
improvements are:
1.
Divide the capital recovery period into 100% to find the annual recapture rate.
2.
Add the recapture rate to the yield or interest rate.
3.
The total is the composite capitalization rate.
4.
Apply to the portion of the net income that is earned by the improvements.
5.
The result is an estimate of improvement value.
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Chapter 14
From the text, Example 14-6:
Example:


The market anticipates a 9% yield on the property investment.
Recapture period is 40 years.
Interest rate
Plus: Recapture rate: (100% ÷ 40)
Equals: Composite rate for improvements
9.0%
+ 2.5%
11.5%
An alternative involves calculating an overall rate. This requires that you know the building ratio, that is,
the building-to-total value ratio.
1.
Multiply the building ratio by the recapture rate.
2.
Add the results to the interest rate.
3.
The result is the calculated overall rate.
4.
Capitalize the total net income to estimate total property value.
[Instructor: See your textbook for an example of this calculation.]
14.3 DIRECT AND RESIDUAL CAPITALIZATION TECHNIQUES
Direct capitalization measures the total property value. The three other methods presented here seek to
value a specified portion of the total property value. The total value can then be solved.
Direct Capitalization Technique
This is the most simple and reliable method of income capitalization, and the most commonly used. It is
recommended for use when there is some similarity in the:
 Size and character of properties
 Ratio of land to buildings
 Outlook for investment risks and value trends
Example 14.7 Direct Capitalization Technique
Net operating income (Io)
Divided by: Overall capitalization rate (Ro)
Equals: Indicated value (Vo)
$100,000
÷ 10%
$1,000,000
Equity Residual Technique
This technique is recommended for use when:
 Analyzing the cash flow from an investment.
 Seeking to value the buyer’s equity position relative to a proposed or existing loan.
 Seeking the value “as financed,” or the “investment value.”
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Chapter 14
Example 14.8 Equity Residual Technique
Assume a net operating income of $100,000, a loan amount of $600,000, annual loan
payments of $70,000, and an equity cash-on-cash rate of 7%.
Solution
Net operating income (Io)
Less: Loan payments (Im)
Equals: Equity cash flow (Ie)
Divided by: Equity cash-on-cash rate (Re)
Equals: Indicated equity value (rounded) (Ve)
Plus: Loan amount (Vm)
Equals: Total value estimate (Vo)
Rounded
$ 100,000
-70,000
$ 30,000
_÷ 0.07
$ 429,000
+ 600,000
$1,029,000
$1,000,000
Building Residual Technique
Recommended for use when:
 Land value is known (or can be demonstrated).
 Older buildings are being appraised.
 The sales data are inadequate to derive a reliable overall rate.
Example 14.9 The Building Residual Technique
Assume a NOI of $ 91,000; a land value of $200,000; an interest rate of 7% for both land
and improvements; and a recapture rate of 4%.
Net operating income
Less: Return required on land:
Land value
$200,000
Times: Land interest rate
x 0.07
Equals: Land return
Equals: Net income to improvements
Divided by composite rate:
Interest rate
0.07
Plus: Recapture rate
+ 0.04
Equals: Composite building cap rate
Equals: Indicated improvement value
Plus: Land value
Equals: Property value
$ 91,000
- 14,000
$ 77,000
÷ 0.11
$700,000
+200,000
$900,000
Land Residual Technique
Recommended when the building value can be reliably estimated but the land value is unclear or
unknown. Also used when improvements are new or near new, and represent the highest and best use.
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Chapter 14
Example 14.10 Land Residual Technique
Assume a net operating income of $70,000; a building cost new of $600,000; an interest
rate of 6.5%, and a recapture rate of 2.5%.
Net operating income
Less: Income to building:
Improvement value
Times: Composite rate:
Interest rate
Plus: Recapture rate
Equals: Composite rate
Equals: Income to building
Equals: Income to land
Divided by: Interest rate
Equals: Land value (rounded)
Plus: Improvement value
Equals: Property value
Rounded
$ 70,000
$600,000
0.065
+ 0.025
x 0.09
- $ 54,000
$ 16,000
÷ 0.065
$246,000
+ $600,000
$846,000
$850,000
Other Capitalization Theories
All income capitalization techniques fall into two basic groups: “ratio” capitalization, and “yield”
capitalization.
Ratio capitalization includes the direct capitalization techniques presented above, when no specific yield
assumptions are made.


It capitalizes the income attributed to the property component under study with a single cap rate,
or value “ratio.”
Ratio capitalization does not explicitly address any possible future income and value changes for
the property.
Yield capitalization is a more sophisticated method of analyzing an investment. It uses “discount” math
(in one form or the other) to value either the property or the equity income. Either short-term or long-term
investments can be appraised.
True investment yield can be analyzed by factoring in all or some of the following:
1.
Anticipated changes in property or equity income over time
2.
Buildup of equity from loan amortization
3.
Value appreciation or depreciation over time
Discounted cash flow (often referred to as DCF) is the most common example of yield capitalization.
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Chapter 14
14.4 ESTIMATING, MEASURING, AND DISCOUNTING CASH
FLOWS
Yield capitalization is used to estimate the present value of a stream of future cash flows. It requires an
explicit estimate of:
1. Future cash flows or their pattern
2. The time period of the projection – the holding period
3. The yield rate (discount rate, interest rate or internal rate of return)
The Use of Cash Flows in Appraisals
The analysis of cash flow lies at the heart of income property investment, appraisal, financing, and
management. Cash flow comes in various forms, including investment income or profit, retirement of
debt, and/or projected sales proceeds. The mathematical tools are the same as those used in yield
capitalization.
Yield capitalization can lead to either an estimate of market value or an estimate of investment value. The
type of value estimated depends on whether the cash flows and discount factors are market derived or
unique to the investor.
Yield capitalization is particularly useful when the net income cash flows and/or value are expected to
change significantly over time. [Instructor: see text for list of reasons for change]
Estimating Cash Flows
All of the cash flows in an investment can be attributed to either periodic income, or to the proceeds from
the sale (or refinance) of the property. Cash flows can be measured either before or after income taxes,
but only pretax cash flows are discussed here. The actual cash flow amounts depend upon:
a.
b.
c.
The income producing ability of the property
The financing involved
The value of the property upon future sale
Measuring Cash Flow from Periodic Income
Cash flow to the equity investor is defined as net operating income less debt service. Cash flows can be
even each period, or uneven.
Example of Even Cash Flow
Assume that a property has an income of $100,000 from a 30-year net flat lease. There is an amortized
30-year, $700,000 loan commitment on the property at 9% interest, payable annually. The cash flow is
calculated as follows (using financial tables to solve for the amount of the annual debt service):
Annual net income (Io)
Less: Annual debt service (Im)
Equals: Annual equity cash flow (Ie)
$100,000
- 68,135
$ 31,865
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Chapter 14
Example of Uneven Cash Flow
Use the same assumptions, except assume that the lease income steps up after 15 years to $150,000 per
year. Cash flows would be as follows:
Years 1-15
Annual net income
Less: Annual debt service
Equals: Annual equity cash flow
Years 16-30
$100,000
- 68,135
$ 31,865
$150,000
- 68,135
$ 81,865
Income Projections





Step one is to select the time period (holding period) to be analyzed
Step two is to understand market rents on the date of value
Step three is to examine changes in the market rents in the past and try to understand what forces
in the local economy are behind the past income changes
Step four is to use this understanding to consider future forces in the market and their impact on
market rents
Step five is to consider any leases and their impact on rents (income) for each future period
Measuring Cash Flow from Sale Proceeds
Estimate the value of the property at time of eventual sale, and deduct:
1.
Any marketing and escrow/title costs expected to be incurred
2.
Any remaining loan balance or payoff
Referring to the earlier example, assume a sale subject to the existing lease after 15 years, and cash to a
new loan. Use a capitalization rate of 10% of the lease income. Assume a broker’s fee and closing costs
totaling 6%. (Text, Example 14-11.)
Sale price:
Annual net income, Io
$150,000
Divided by: Cap rate, Ro
÷ 0.10
Equals: Sale price, Vo
Less: Marketing and closing costs:
Sale price
$1,500,000
Times: Costs in percent
x 6%
Equals closing costs
Equals: Net price before loan payoff
Less: Loan balance (from tables)
Equals: Cash flow from sale proceeds, Ve
$1,500,000
- 90,000
$1,410,000
- 549,219
$ 860,781
Estimating the Future Sale Price
Two common methods to estimate future sale price:
1. Capitalize the projected income at that time (more commonly used)
2. Estimate future value as an annual percent change from value on the date of value
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Chapter 14
The projected income method uses:
 The existing annual cash flow projection
 An estimate of income and cash flow for the year following the projection (estimated income for
the year following the resale date) – i.e. 11th year net in the case of a 10-year projection
 Capitalize the projected income, using a going-out OAR.
The projected value change method involves:
 An estimate of value on the date of value
 An estimate of value change for each year of the projected time period – the same each year, or
changing – based on market interviews.
Discounting Cash Flows
The Theory of Discount Math
1.
When you place $1.00 in a 5% account, you are recognizing that the $1.05 promised in one year
has only a $1.00 present value.
a.
b.
2.
The deposit is less than the future amount.
Hence, $1.00 is the discounted present value of $1.05, to earn 5%.
The discount factor in the previous example is the ratio of $1.00 to $1.05, or $1.00 ÷ $1.05 =
.95238.
a.
b.
The same factor can be used for any sum that is due one year in the future, when
discounted at 5%.
For the lump-sum amount of $1.05 due in one year, here are the calculations that show
the present value to be one dollar:
Amount due in the future
$1.05
Times: Discount factor: x .95238
Equals: Present value
$1.00
How to Estimate a Factor
 Using discounting math requires using a factor
 The factor is a number that adjusts for the time value of money
 Sources of factors:
- Look up in a table (Example 14-12)
- Calculate with a financial calculator
- Calculate using the formula for the factor
 Six common factors (i.e. six functions of the a dollar); forming three pairs:
- The present value of a future dollar (the reversion factor), and the future worth of a present
lump-sum (the future value factor)
- The present value of a future income stream, and the future worth of an income stream
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Chapter 14
- The periodic payment to pay off a present sum (the loan constant or loan factor), and the
periodic payment to accumulate to a future lump-sum (the sinking fund factor)
 All six factors involve:
- An interest rate
- A time period
 Periodic payments are always level
Financial Calculators
Often used to calculate financial factors – many brands, such as Hewlett Packard, Texas Instruments, and
others – many models, with the HP12C the most common.
Method:
1. Enter a number
2. Hit a key to identify what the number is:
a.
b.
c.
d.
e.
present value (PV)
future value (FV)
periodic payment (PMT)
time period (N)
a rate (usually i)
3. After the known numbers have been entered, hit the key for the answer, the unknown, to start the
calculation.
Printed tables have been essentially replaced by financial calculators.
Discount Formula for a Single Payment
Discount factors, built into financial tables and calculators are based on single payment amounts of $1.00,
so that any dollar amount can be applied against the factor. Here is the basic mathematical formula used:
Present value of $1.00 = 1 ÷ (1 + i)n
Where
i = discount rate
n = number of future time periods
Using a financial calculator to solve for the discount factor shown earlier, the variables are entered, and
the solution found is as follows, where FV refers to future value, and PV to present value:
Given: n = 1; i (in %) = 5; FV = $1.00
To solve: PV = $0.95238
Discounting a Stream of Payments
We can discount an income stream using financial tables, or with a calculator.
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Chapter 14
Using the 15-year income stream given in the example above, we will discount a stream of payments,
using financial tables:
1.
Assuming an investor would require a 12% yield, we refer to a 12% financial table, in the
column referred to as the “present worth of one per period.”
2.
For 15 years, we find listed the factor of 6.8109.
3.
When this present worth factor is multiplied times the annual income (after debt service,
the equity cash flow), the present worth of the income stream is calculated:
$31,865 X 6.8109 = $ 217,000 (rounded).
Using a financial calculator, the same variables are entered, and the problem solved as follows, where
PMT is the annual cash flow amount:
Given: n = 15; i (in %) = 12; PMT = $31,865 (be sure FV = 0)
To solve: PV = $217,000 (rounded)
Discounting the Sale Proceeds
The sale proceeds is a single cash flow, projected to be available when an investment property is sold.
Referring again to the investment analysis example cited above, we discount the net proceeds of
$860,781, using financial tables.
1. The projected net sale proceeds of $860,781 will be available in 15 years.
2. We refer to a 12% “present worth of one” table at 15 years to find the discount factor at the
investor’s required yield, 0.1827.
3. We multiply the factor times the net proceeds, as follows:
$860,781 X 0.1827 = $157,250 (rounded)
Using a financial calculator, the same answer is calculated, as follows:
Given: n = 15; i (in %) = 12; FV = $860,781 (be sure PMT = 0)
To solve: PV = $157,250 (rounded)
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Instructor’s Manual: Basic Real Estate Appraisal, 8th. Edition
Chapter 14
Summary of Anticipated Cash Flows
1.
Equity cash flow:
Net annual income
Less: Debt service (from above)
Equals: Net annual equity cash flow
2.
$ 100,000
- 68,135
$ 31,865
Equity sale proceeds:
Future sale price
Less: Selling costs
Less: Loan balance
Equals: Equity sale proceeds
$1,500,000
- 90,000
- 549,219
$860,781
Summary of Discounted Cash Flows
The cash flows shown above are discounted to solve for the present worth of the equity investment,
suggesting the amount of down payment warranted, given the investor’s yield requirement of 12%:
Cash Flow
Income Stream
Sale Proceeds
Amount
$ 31,865
$860,781
Discount Factor
x
x
6.8109
0.1827
Total Present Worth of Equity
Rounded:
Present Value
=
=
$217,000
+ 157,250
$374,250
$374,000
SUMMARY
[Instructor: The list of important terms may assist in your summary.]
Important Terms and Concepts
Annuity recapture method
Band of investment method
Building residual technique
Capital recovery
Capitalization rate
Cash flow
Composite capitalization rate
Debt service
Delta (value change)
Direct capitalization
technique
Direct comparison method
Discount rate
Discounted cash flow (DCF)
Equity Hypothecation
dividend rate
Equity Interest
residualrate
technique
Equity yield rate
Going-in OAR
Going-out OAR
Hypothecation
Income stream
Interest rate
Internal rate of return
Investment value
Land residual technique
Leverage
Mortgage constant
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Overall capitalization rate
(OAR)
Yield capitalization
Periodic rate
Ratio capitalization
Recapture rate
Reversion
Safe rate
Straight-line recapture
method
Summation method
Time value of money
Yield capitalization
Yield rate
Instructor’s Manual: Basic Real Estate Appraisal, 8th. Edition
Chapter 14
REVIEWING YOUR UNDERSTANDING
[Instructor: See end of text chapter for student review questions.]
STUDENT EXERCISES
[Instructor: Suggested Multiple Choice and True/False questions are available to use for Chapter
14.]
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