Yield Capitalization Explained
Yield capitalization is a method for opinions of value. It is also known as discounted cash flows and pro forma modeling. It is one of the four most commonly used methods of determining value of a property. Other three methods are Direct Comparison, Cost Approach, and Direct Capitalization. Each of these has a different procedure of implementation, and is suitable for varying types of commercial properties.
Difference between Yield Capitalization and Direct Capitalization
Main feature that differentiates yield capitalization from Direct Capitalization is ‘time period’. The former takes more time for analysis. It produces more dynamic representation of cash flows, and not for a single year cash flow. In this method, calculation for several years is made rather than for a single year. It is shown in one pro forma statement that mentions mortgage payment and all other related expenses in reconstructed income as well as expense statements.
In yield capitalization, experts assess the value of a projected income stream from discounted cash flows. This procedure converts future income from a property into a present value. This is carried out by discounting the income from each year with an appropriate discount rate. For the assessment of irregular income streams, variables are anticipated and taken into pro forma statements. Rent increase is one of the most common variables in commercial real estate. In Yield Capitalization, the amount and timings of cash flow are considered. It also involves growth or decline in value of assets.
What is Cash flow?
It is the pattern of income and expenses of a company or an individual. It is the net income or cash receipts from a single or multiple assets in a given time period.
Popular among commercial real estate owners
Yield capitalization is highly popular. Realtors and investors rely upon this method of property evaluation. This is because it provides accurate estimates that are nearest to the factual data.
A typical statement in Yield Capitalization involves several calculations including mortgage, potential rental income, operating expenses, non-operating expenses, gross operating income, net operating income, marginal cash flows and so on. All calculations are carefully made to get accurate results.
Advantages and disadvantages
All methods of opinions of value have their pros and cons.If you implement Yield Capitalization method for property value estimate, you will notice that it results in higher prices for the sellers. It attracts new buyers. It suits sophisticated customers only.