Income capitalization – What it is, definition and concept | 2022

The capitalization of rents is a method of calculating the appraisal value of real estate that allows calculating its current value based on the future rents expected for its rental.

This is a concept related to financial capitalization and update operations. In this case, applied to real estate rentals. The goal is to get to know how much it would be worth today based on what we expect to get for it in the future.

It would be the case of a commercial premises, or a house, that we hope to rent and we want to know how much it could cost today if it were paid in cash. In this way, what we do is update the income that we expect to obtain using an interest rate and a financial law.

Income capitalization application requirements

Of course, we can only apply it to properties that are used as an investment. That is, in those from which we expect a return. Thus, the habitual residence would not enter into this assumption, since it does not generate income but expenses.

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In addition, the capitalization of income is regulated by law in many countries. For example, in Spain, you need to have a time horizon of at least six months to calculate it. In this way, the approximate value of the rents that would be obtained can be predicted.

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Income capitalization and finance

On the other hand, in general, this method is very common in finance. In fact, in financial mathematics, capitalization is taking income to a future moment. An example is a pension plan from which we want to know the money we will receive in a few years.

For its part, the update would be a reverse capitalization, since we would go backwards. In this case, the most common example is a loan. Its amount is nothing more than the value of the money that the bank lends us updated to the year in which it is granted to us, depending on what we will pay.

Example

Let’s see, to finish an example. Let’s imagine a property that has been rented for 12 months at 350 euros per month. We want to know the appraised value for the method we are looking at. To carry it out we will take into account the data and interest rate of 3%, which is fictitious.

What we do is calculate the value of future income (€350) at the present time. Through a complex financial operation, we obtain the appraisal value by the income capitalization method. Of course, we must also take into account a series of necessary expenses.

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