How does direct capitalization differ from yield capitalization?

Direct capitalization differs from yield capitalization primarily in its approach to evaluating cash flows and income generated by a property. In the direct capitalization method, the first-year net operating income (NOI) of a property is typically used to determine its value. This method capitalizes the income based solely on that immediate cash flow figure, applying a capitalization rate to arrive at a property valuation. This approach is particularly useful for properties with stable, predictable income sources, as it delivers a straightforward valuation based on current performance without a deep dive into future cash flows or trends.

In contrast to direct capitalization, yield capitalization takes into account the entire stream of future cash flows over multiple years, assessing how those cash flows are expected to change over time and incorporating various discount rates. This method provides a broader analysis, reflecting potential future performance rather than just the initial year.

Therefore, focusing on first-year cash flows is what sets direct capitalization apart and underlines why this characteristic is critical to understanding its function within real estate valuation methodologies.