The process of converting periodic income into a value estimate is referred to as income capitalization. Income capitalization models can generally be categorized as either direct capitalization models or discounted cash flow models. Which of the following statements best describes the direct capitalization method?
A) Value estimates are based on a multiple of expected first year net operating income.
B) Appraisers must make explicit forecasts of the property's net operating income for each year of the expected holding period.
C) Appraisers must select the appropriate yield at which to discount future cash flows.
D) The forecast must include the net income produced by a sale of the property at the end of the expected holding period.

Question

Quizplus · Accepted Answer

The direct capitalization method estimates the value of a property by capitalizing its net operating income (NOI) in the first year of ownership using a market-derived capitalization rate (cap rate). The cap rate is derived from sales of similar properties in the market and represents the expected return on investment for the property type and location. The formula for direct capitalization is Value = NOI / Cap Rate. Therefore, the value estimate is based only on a multiple of expected first-year NOI.

The Process of Converting Periodic Income into a Value Estimate