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The Functional Relationships and Use of Going-In and Going-Out Capitalization Rates

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Abstract

In performing a Discounted Cash Flow Analysis for an income-producing property, a traditional rule-of-thumb indicates that the going-out capitalization rate should be one-half to one percent higher than the going-in capitalization rate. So far, there has been no theoretical model or empirical evidence to support or to dispute this assertion. This paper develops a model to examine the determinants of the going-out capitalization rate, as well as the relationship between going-in and going-out capitalization rates in a complete market setting. The proposed model indicates that the rule-of-thumb can be challenged, and the selection of an appropriate going-out capitalization rate requires a careful examination of the changes in the assumed income-growth rates, changes in the assumed required rates of return, and changes in the assumed property-appreciation rates during and after the projected holding period. The functional relationship between the property-appreciation rate assumption required for Ellwood methods and the going-out capitalization rate assumption required for DCF analysis also is derived.

Suggested Citation

  • Ko Wang & Terry V. Grissom & Su Han Chan, 1990. "The Functional Relationships and Use of Going-In and Going-Out Capitalization Rates," Journal of Real Estate Research, American Real Estate Society, vol. 5(2), pages 231-246.
  • Handle: RePEc:jre:issued:v:5:n:2:1990:p:231-246
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    References listed on IDEAS

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    1. Karl L. Guntermann & Richard L. Smith, 1987. "Derivation of Cost of Capital and Equity Rates from Market Data," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 15(2), pages 98-109.
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    Cited by:

    1. Gaetano Lisi, 2016. "General equivalency between the discount rate and the going-in & going-out capitalization rates," Economics and Business Letters, Oviedo University Press, vol. 5(2), pages 58-64.
    2. Gaetano Lisi, 2015. "Hedonic prices, capitalization rate and real estate appraisal," Economics Bulletin, AccessEcon, vol. 35(1), pages 783-787.
    3. G. Donald Jud & Daniel T. Winkler, 1995. "The Capitalization Rate of Commercial Properties and Market Returns," Journal of Real Estate Research, American Real Estate Society, vol. 10(5), pages 509-518.

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    JEL classification:

    • L85 - Industrial Organization - - Industry Studies: Services - - - Real Estate Services

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