Performance compounding explained
Yield compounding is a method for value opinions. Also known as pro forma and discounted cash flow models. It is one of the four most used methods to determine the value of a property. Three other methods are Direct Comparison, Cost Approach, and Direct Capitalization. Each of these has a different implementation procedure and is suitable for different types of commercial properties.
Difference between yield capitalization and direct capitalization
The main characteristic that differentiates yield compounding from direct compounding is the “time period”. The former requires more time to analyze. It produces a more dynamic representation of cash flows, and not for a single year cash flow. In this method, the calculation is made for several years instead of a single year. It is shown on a pro forma statement that lists the mortgage payment and all other related expenses on the reconstructed income and expense statements.
What is included?
In performance compounding, experts evaluate the value of a projected income stream from discounted cash flows. This procedure converts future income from a property to present value. This is done by discounting each year’s income at an appropriate discount rate. For the evaluation of irregular income flows, the variables are anticipated and taken in pro forma statements. Rent increases are one of the most common variables in commercial real estate. In Yield Capitalization, the amount and timing of the cash flow are considered. It also implies an increase or decrease in the value of assets.
What is cash flow?
It is the pattern of income and expenses of a company or an individual. It is the net income or the cash income of one or more assets in a given period of time.
Popular with commercial real estate owners
Yield compounding is very popular. Real estate agents and investors trust this method of property evaluation. This is because it provides accurate estimates that are closer to the factual data.
Statement sample
A typical statement in Yield Capitalization involves various calculations including mortgages, potential rental income, operating expenses, non-operating expenses, gross operating income, net operating income, marginal cash flows, etc. All calculations are done carefully to obtain accurate results.
Advantages and disadvantages
All value opinion methods have their pros and cons. If you implement the return capitalization method for estimating property value, you will notice that it results in higher prices for sellers. Attract new buyers. Suits only sophisticated clients.