Cost of Capital: Applications and Examples, + Website, 5th Edition

CHAPTER 40

Cost of Capital of Real Property—Individual Assets¹

Thomas Hamilton

Introduction

Typical Structure of a Real Estate Transaction

Real Property Competes with Other Asset Classes

Direct Capitalization Method

Overall Direct Capitalization

Band of Investment Method

Estimating the Capitalization Rate

Residual Methods

Discounted Cash Flow Method

Estimating the Property Discount Rate

Summary

Appendix 40A: Valuing Real Property

INTRODUCTION

This chapter presents development of the cost of capital for individual real property investments and provides practical applications for the valuation of income-producing assets, such as apartment or office buildings, industrial properties, and development properties. In conjunction with the other chapters in this book, this chapter assists the reader in understanding the differences between the current practices applied in business valuation and those applied in real estate valuation. The income and the cost of capital associated with the ownership of real property rights are the focus of this section. This is different from the income and cost of capital that might be earned by a business enterprise operating on the property, such asa marina, hotel, fitness club, or restaurant, or a portfolio of properties, such as a real estate operating company or a real estate investment trust.

Real estate is a unique asset class with distinguishing characteristics. Real estate is immobile, durable, or indestructible, and each parcel is different in ...