Rates and Ratios Book

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Rates and Ratios used in the Income Capitalization Approach

Introduction: This handbook is a compilation of information regarding the rates and ratios used in the income capitalization approach as currently presented in the Appraisal Institute's educational curriculum. The presentation of some of the material, however, may vary slightly as various nuances are explored that are only implicit in the course or seminar offerings. This is not a textbook in income capitalization. Rather, it assumes that readers are involved in appraisal work (performance or review) and the procedures used in income property analysis.

Many times, in the preparation or review of an appraisal report, a question is raised regarding the magnitude of a rate or a ratio with respect to other numbers presented. Appraisers must be able to identify and avoid contradictions and inconsistencies that could destroy the credibility of their conclusions. Reviewers must not only be able to identify contradictions and inconsistencies, but also have a source of information to accept an infrequently used technique that is appropriate with the available data.

For example, lenders use risk aversion tools (loan-to-value ratios and debt coverage ratios) to reduce their risk below that of a non-leveraged owner. As a result the lender's yield (Ym) is virtually always less than the property's yield (Yo). The selection of a property discount rate (Yo) that is less than or equal to prevailing interest rates for a particular type of property would be an apparent error. The competent appraiser, therefore, will either correct the mistake or, if the market clearly supports that relationship, offer the reader of the appraisal report a convincing explanation. Either of the above will be beneficial to a review appraiser.