The Capitalization Approach to Income Property Valuation
Definition of capitalization of earnings
By Dan Harkey
The concept of the capitalization approach is a method of estimating the fair value of an asset such as incomeproducing real estate by calculating the net present value ( NPV ) of expected future net profits or net cash flow referred to as Net Operating Income . The capitalization of earnings is determined by taking the property ’ s projected annual net income and dividing it by the market capitalization rate ( Cap Rate ).
Understanding the income capitalization approach ( Cap Rates ) in the property valuation process is critical when investing in incomeproducing real estate or obtaining a loan . This concept is essential to commercial Realtors ®, lenders , developers , and investors in incomeproducing real property . The concept is commonly referred to as the income approach .
Net income divided by the capitalization rate will reflect the expected value of the incomeproducing asset . Restated : Net operating Income divided by the capitalization rate = value ( NOI / Cap Rate = Value ).
Example : Property Income and Expense Statement Format This formula below is used to calculate the Net Operating Income
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