Certified Residential Appraiser Practice Exam

Which two methods are commonly used for income capitalization?

1. Direct Cap and Income Approach

2. Direct Cap and Discounted Cash Flow

3. Discounted Cash Flow and Cost Approach

4. Income Approach and Sales Comparison Approach

The correct answer is: Direct Cap and Discounted Cash Flow

The choice of Direct Capitalization and Discounted Cash Flow as the correct methods for income capitalization is based on their specific application in valuing income-producing properties. Direct Capitalization specifically assesses a property's value based on its expected income in a single year, capitalizing that income into a present value by applying a capitalization rate. It is straightforward and provides quick estimates of value based on current rental income, making it widely applicable for properties with stable and predictable income. On the other hand, Discounted Cash Flow analysis expands on the Direct Capitalization method by considering expected future cash flows over multiple years rather than just a single period. By projecting the income over a designated holding period and discounting those future cash flows back to their present value using a discount rate, this method accounts for changes in income and expenses over time, capturing the value of the property more comprehensively, especially for properties with fluctuating income. These two methods are integral to income capitalization as they both focus on the income potential of the property but differ in their approach and the time frame considered, allowing appraisers to choose the most suitable method based on the specific circumstances of the property in question.