Cyclical capitalization and lag vacancy

Abstract

Purpose This paper aims to propose a new valuation method for income producing properties. The model originally called cyclical dividend discount models (d’Amato, 2003) has been recently proposed as a family of income approach methodologies called cyclical capitalization (d’Amato, 2013; d’Amato, 2015; d’Amato, 2017). Design/methodology/approach The proposed methodology tries to integrate real estate market cycle analysis and forecast inside the valuation process allowing the appraiser to deal with real estate market phases analysis and their consequence in the local real estate market. Findings The findings consist in the creation of a methodology proposed for market value and in particular for mortgage lending determination, as the model may have the capability to reach prudent opinion of value in all the real estate market phase. Research limitations/implications Research limitation consists mainly in a limited number of sample of time series of rent and in the forecast of more than a cap rate or yield rate even if it is quite commonly accepted the cyclical nature of the real estate market. Practical implications The implication of the proposed methodology is a modified approach to direct capitalization finding more flexible approaches to appraise income producing properties sensitive to the upturn and downturn of the real estate market. Social implications The model proposed can be considered useful for the valuation process of those property affected by the property market cycle, both in the mortgage lending and market value determination. Originality/value These methodologies try to integrate in the appraisal process the role of property market cycles. Cyclical capitalization modelling includes in the traditional dividend discount model more than one g-factor to plot property market cycle dealing with the future in a different way. It must be stressed the countercyclical nature of the cyclical capitalization that may be helpful in the determination of mortgage lending value. This is a very important characteristic of such models.

“Cyclical assets” and cyclical capitalization

“…In this specific case, the temporal length adopted is three years and it replaces the temporal length of the property market phase. Following previous evidences (d’Amato, 2009; d’Amato, 2015; d’Amato, 2017b; d’Amato et al , 2017), the final result is a prudent opinion of value included in the interval between two traditional direct capitalizations based on a single all-risk yields both in an upturn and in a downturn of the market. The method may represent a possible methodology to determine mortgage lending value for minor sensibility to the upturn and downturn of the market.…”

“…Specific applications of these models to London Office Market has been recently proposed (d’Amato, 2015; d’Amato and Amoruso, 2018). A further integration between cyclical capitalization models and lag vacancy has been offered (d’Amato, 2017b). In this contribution, an application of these models to London office market is provided, exploring the relationship between lease contract and property market cycle in the application of such methodology for cyclical assets estimation.…”

“…Another important issue is the relationship between property market cycle and contractual rent. In the previous work, cyclical capitalization have been applied to leasehold properties (d’Amato, 2015; d’Amato, 2017b), assuming the temporal length of the market phase t approximately equal to the temporal length of the contractual rent n. In this way, reversion will be calculated applying Equation (7) because contractual rent will follow more or less the market trend as in Figure 1 below.…”

“…Figure 1 shows the time series of the rate of change in the backward holding period from 1998 to 2008. A backward holding period (d’Amato, 2015; d’Amato, 2017a; d’Amato, 2017b) of 10 years is assumed because it is clearly possible to observe both the recovery recession and the expansion contraction phases of the cycle in the South Bank area of the London office market as in Figure 3 below.…”

“…The temporal length of the property market phase of five years will be replaced with temporal length of the contract of three years. In this application, it is supposed that lag vacancy is approximated to zero, even if it is possible to include it in cyclical capitalization modelling (d’Amato, 2017b). Consequently, this cyclical capitalization model will have two different all-risk yields representing two different property market phases.…”