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Income capitalisation method and hedonic model: an integrated approach

Gaetano Lisi (Department of Economics and Law, Universita degli Studi di Cassino e del Lazio Meridionale, Cassino, Italy)

Journal of Property Investment & Finance

ISSN: 1463-578X

Article publication date: 21 February 2019

Issue publication date: 29 March 2019

491

Abstract

Purpose

The purpose of this paper is to provide an integrated approach that combines the two methods usually used in the real estate appraisals, namely, the income capitalisation method and the hedonic model.

Design/methodology/approach

In order to pull out the link between the income capitalisation approach and the hedonic model, the standard hedonic price function is introduced into the basic model of income capitalisation instead of the house market value. It follows that, from the partial derivative, a direct relation between hedonic prices and discount rate can be obtained. Finally, by using the close relationship between income capitalisation and direct capitalisation, a mathematical relation between hedonic prices and capitalisation rate is also obtained.

Findings

The developed method allows to estimate the capitalisation rate using only hedonic prices. Indeed, selling and hedonic prices incorporate all of the information required to correctly estimate the capitalisation rate. Furthermore, given the close relation among going-in and going-out capitalisation rates and discount rate, the proposed method could also be useful for determining both the going-out capitalisation rate and the discount rate.

Practical implications

Obviously, it is always preferable to estimate the capitalisation rate by just using comparable transactional data. Nevertheless, the method developed in this paper is especially useful when: the rental income data are missing and/or not entirely reliable; the data on rental income and house price are related to different homes; the capitalisation rate, in fact, should compare the rent and value of identical homes. In these cases, therefore, the method can be a valuable alternative to direct estimation.

Originality/value

The large and important literature on real estate economics and real estate appraisal neglects the relationship between hedonic prices and capitalisation rate, thus considering the hedonic model and the income capitalisation approach as two separate and alternative methods. This paper, instead, shows that integration is possible and relatively simple.

Keywords

Acknowledgements

The author is indebted to two anonymous referees for their many valuable comments and suggestions that have significantly improved the paper.

Citation

Lisi, G. (2019), "Income capitalisation method and hedonic model: an integrated approach", Journal of Property Investment & Finance, Vol. 37 No. 3, pp. 289-300. https://doi.org/10.1108/JPIF-11-2018-0088

Publisher

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Emerald Publishing Limited

Copyright © 2019, Emerald Publishing Limited

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