Yield Capitalization
Notice that the discount rate used in the DCF model for discounting future cash flows is a yield rate and is very different from the capitalization rate or cap rate used in the direct capitalization approach.
1. Yield rates take into account potential fluctuations in Net Operating Income (NOI) over the holding period, while the cap rates do not. 2. Yield rates take into account income taxes and capital expenditures as the discount rate in the DCF model is typically applied to after-tax cash flows, while the cap rate is applied to the NOI, which although it takes into account property taxes it does not account for income tax payments and capital expenditures.
4. The yield rate reflects therefore the total return (income return plus appreciation return) the average market investor would require for the property that is valued given its risk level. The cap rate reflects only the required income return by the investor. 5. Yield rates can not be extracted from market transactions, while cap rates are typically extracted from direct market transactions for which the sales price and the NOI of the transacted property are known. Tweet
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