What does single-period direct capitalization do?
Correct Answer
C) Convert one period’s income to value with a compatible rate or factor.
Direct capitalization converts a representative single-period income to an indication using a compatible capitalization rate or factor. Market-derived rates may embed growth and finite-life expectations; the method does not universally assume a literal level perpetuity. Forecasting many dated receipts is a DCF formulation.
Why This Is the Correct Answer
Option C is correct because direct capitalization converts one period's income to value with a compatible capitalization rate or income factor. It does this in one step, either by dividing income by a rate or multiplying it by a factor. Market-derived rates can reflect expectations about growth and risk without forecasting each year.
Why the Other Options Are Wrong
Option A: Discount each dated forecast receipt separately to present value.
Option A describes discounting each dated forecast receipt separately to present value. That is yield capitalization or discounted cash flow analysis, not single-period direct capitalization.
Option B: Deduct operating expenses, without converting the income to a value.
Option B describes deducting operating expenses without converting income to value. Deducting expenses produces NOI, but direct capitalization is the step that converts income into a value indication.
Option D: Replace the terminal sale proceeds with an annual loan payment.
Option D describes replacing terminal sale proceeds with an annual loan payment. That does not describe any capitalization method; loan payments relate to financing, and terminal proceeds belong to a multi-period analysis.
One year, one step
Direct capitalization takes one year of income and converts it to value in a single division or multiplication.
How to use: Use this to tell direct capitalization apart from discounted cash flow options.
Exam Tip
If an answer mentions discounting multiple dated cash flows, it describes yield capitalization rather than direct capitalization.
Common Mistakes to Avoid
- -Confusing direct capitalization with discounted cash flow analysis
- -Thinking deducting expenses alone produces a value
- -Assuming direct capitalization literally assumes level perpetual income
Concept Deep Dive
Analysis
This question tests the definition of direct capitalization. The method converts a single period's income into a value indication in one step, using a compatible rate or factor. It differs from discounted cash flow analysis, which treats each dated receipt separately.
Background Knowledge
Direct capitalization uses an overall rate or income multiplier to turn a single year's income into value. Yield capitalization, including discounted cash flow analysis, discounts a series of future benefits, including any reversion, at a yield rate.
Real-World Application
For a stabilized, fully leased office building, an appraiser divides next year's NOI by a market-extracted overall rate. For a property in lease-up, the appraiser adds a discounted cash flow analysis to model changing income over time.
More Income Approach Questions
Which model describes yield capitalization of property benefits?
An appraiser is valuing a duplex. A market survey of recent duplex sales reports prices at 10.8 times potential gross income, with stabilized vacancy and credit loss of 10% of PGI and no other income. The subject's rent schedule is unavailable, but the property manager's records show collected income of $54,000 a year, in line with market rent and the 10% market loss. What value is indicated?
The subject property is a fourplex with annual EGI of $72,000 and operating expenses of $28,800. Of those expenses, $18,000 is fixed and $10,800 varies in direct proportion to EGI. The owner's annual mortgage payments are $21,000. An appraiser projects that EGI will fall 10% because of higher vacancy. What is the projected NOI?
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