Capitalization :Direct vs. Yield Norair Yeretsian

Direct Capitalization Rate, also referred to as overall cap rate (OCR) ,
it is the overall return from an income producing property on an all cash position.
It represents the one year view of the property.
The formula is derived from the income approach to value :

OCR = NOI / Value   :

overall cap rate equals net operating income divided by value.

example : OCR   is    10 %    =   321,600   /  3,216,000

Yield Capitalization is a more dynamic perspective of the property
and it relies on discounted cash flows looking out 5 to 10 years
( or more) into the future of the property’s performance.
This is a lot more work, and with many more assumptions
being required to be made with the associated risk(s).

example :  CFBT # s from initial investment ( year 0) to EOY 1 CFBT … to EOY5 CFBT + SPBT#

time line ( also taking into account the Time Value of Money )

…… Year 0 -)->–EOY 1—EOY2—–EOY3——-EOY4—–EOY5

(804,000) .122,610..137,323..153,802..172,258.. [192,929+1,750,000]

….CFj ……..CFj……..CFj…….CFj ……… CFj……  CFj …

Flow 0 —— 1——– 2——- 3———— 4——– 5 –

Using the HP10BII calculator , you can easily run these cash flows with
the following key stroke entries :

step 1 : make sure your calculator is set to  1  P-YR
[ press shift   1 p_yr to comfirm it]

step 2 : start entering the cash flows with the initial flow
( initial investment ) going in as a negative …
[ press 804,000 then the +/- key to set :
-804,000 enter into [ CFj ]

step 3 : enter the balance of the cash flows
enter the  number 122610 [ CFj] you should see flow 1 quickly
appears and disappear, then enter the next cash flow,
till the final cash flow : make sure you add the together the
EOY5 CFBT + SPBT and enter the total as one cash flow,
otherwise your time value of money ( time line) will be thrown off.

step 4 :  by pressing  the  IRR%/YR  key , the internal rate of return is the yield
on the invested capital in the property ( stated as an annual rate ).

Therefore the result you should get on your display is :  31.01 % .
This is the before tax yield .

If we changed the Sale Proceeds Before Tax to $ 1,000,000
with the EOY5 cash flow and re-ran the numbers the resulting
IRR%/YR would equal : 21.71%

These are both great yields, now the challenge is go out and find them !

We could continue playing a What if game with altering cash flows
over the years and different  revisionary values.

There were a number of positive assumptions embedded in the above
cash flows which may not happen. Caution is the order of the day,
your assumptions must be made clear, rate of increase year over year.
The cost of capital, the rate of inflation, the risk associated with the
asset and the location. Many many more…tenants?

Let talk about it,… twitter : EnvoyCapRealty

or just below…

nyeretsian@yahoo.com May 20, 2010