How do direct capitalization and yield capitalization differ in appraising income property?

Direct capitalization and yield capitalization are both methodologies used in the appraisal of income-producing properties, but they fundamentally differ in how they approach the timing and projection of income.

Direct capitalization involves estimating the value of a property based on its current or projected net operating income (NOI) divided by a capitalization rate. This method typically focuses on a single year of income or an average of recent years but does not consider the income growth or decline beyond that period. It is based on the idea that the income generated in the immediate term is a reliable indicator of value.

On the other hand, yield capitalization (also known as discounted cash flow analysis) accounts for income over a longer time horizon. It projects income for several years into the future and discounts those future cash flows back to their present value using a specified discount rate. This method incorporates expectations of growth or changes in income over time, making it suitable for properties with variable income streams or those expected to experience changes in value.

Given this distinction, the focus on different time spans for income capitalization clearly highlights the main difference between the two methods. Understanding this allows appraisers to choose the appropriate method depending on the specific characteristics of the property and the income projections available.