A number of other valuation techniques make only an implied or no attempt to take account of the time value of money. One technique which is very often used in property valuation is the income capitalisation rate (or multiple) technique.

Income capitalisation rate (or multiple)

Income capitalisation techniques value property on the basis of one year’s expected income. The income is either:

Both represent the relationship between the observed value of property based on market sales and the income expected to be derived from the property.

The estimate of annual income must be representative of the income that the property would normally be expected to generate. The market sales data must refer to properties that are similar with respect to physical characteristics, location, income, expenses and risk.

The income indicates the future benefits the purchaser could expect from ownership. It can be expressed as potential gross income, effective gross income that adjusts for normal vacancy rates and collection losses, or net operating income.

Market capitalisation rates or multiples reflect the time value of money and investment risk, but they are implicitly embedded rather than being explicitly stated as in discounted cash flow calculations.

Example:

 

Activity 

Part (a) An investment property has an expected annual effective gross income of $500,000. Investigations of recent sales price data for comparable properties reveal a 10 per cent market capitalisation rate.

  • Estimate the value of the investment property.
  • Repeat the previous calculation using the income multiplier approach

 

Activity 

Part (b) An investment property has an expected annual effective gross income of $500,000. Investigations of recent sales price data for comparable properties reveal a 5 per cent market capitalisation rate.

  • Estimate the value of the investment property.
  • Repeat the previous calculation using the income multiplier approach.