Capitalization

Capitalization is the process of converting income into an estimate of value for income-producing real property.

• Used in the income approach to value
• Relies on a rate of return
• Based on net operating income (NOI)
• Reflects risk, return, and market conditions

• Most common exam method
• Converts one year’s NOI into value

• Value = NOI ÷ Capitalization Rate
• Cap Rate = NOI ÷ Value

• Net Operating Income (NOI)
  • Gross income − operating expenses
  • Excludes mortgage payments, depreciation, income taxes

• Capitalization
  • Uses net income
  • More precise

• Gross Multiplier
  • Uses gross income
  • Simpler, less precise

• Capitalization applies only to income-producing property
• Higher cap rate = lower value
• Lower cap rate = higher value