Real Estate Appraisal Practice Exam

What is the difference between direct capitalization and yield capitalization in income property appraisal?

1. Direct capitalization considers multiple years of income.

2. Yield capitalization is more straightforward and less accurate.

3. Direct capitalization uses a time span of one year, while yield capitalization covers the entire holding period.

4. Yield capitalization is only used for commercial properties.

The correct answer is: Direct capitalization uses a time span of one year, while yield capitalization covers the entire holding period.

The choice indicating that direct capitalization uses a time span of one year, while yield capitalization covers the entire holding period is accurate. Direct capitalization involves estimating the value of an income-producing property by applying a capitalization rate to a single year’s projected net operating income (NOI). It provides a snapshot of value based on the current income generated, typically reflecting the expectations of what that property can earn in the near term. On the other hand, yield capitalization, also referred to as discounted cash flow analysis, evaluates a property over a longer term, often including multiple years of expected income and considering how the income and expenses will change over time. This method reflects the present value of future cash flows throughout the entire holding period, which can give a more comprehensive picture of an investment's potential. Understanding this distinction helps appraisers determine which method to employ depending on the specific characteristics and investment goals related to the property in question.