Real Estate Valuation Using Cyclical Capitalization Models

This paper is focused on the integration of property valuation and market cycles analysis. Early work in this field (d'Amato, 2003) tried to integrate market analysis and valuation process and reduce the gap between academic research on property market cycles and professional practice of property valuation. In fact, whilst it is well documented that the property market presents a cyclical behavior, income approach in many cases still relies on the assumption that the real estate generate a stable or perpetually growing income. By considering a stable net operating income in a real estate market heaving a cyclical behavior may overestimate the property value in the recession phase of the market and underestimate it in the expansion phase. This may be the reason of the Ponzi effect denounced in Shiller (2002) which partially increased the real estate bubble and the consequent financial markets crisis experienced recently. This paper offers a general introduction on cyclical capitalization that takes into consideration the real estate market cycle, as a further family of income producing properties valuation methodologies. This method, developed based on the traditional Dividend Discount Model, uses more than one growth rate (g) in order to include property market cycle analysis in the value opinion. An empirical application of cyclical capitalization is offered taking into consideration the office market of South Bank in London.