Income capitalisation method and hedonic model: an integrated approach

Publication Date10 April 2019
AuthorGaetano Lisi
SubjectProperty management & built environment,Real estate & property,Property valuation & finance
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
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 Income capitalization method, Hedonic model, Hedonic prices, Capitalization rate
Paper type Research paper
1. Introduction
The capitalisation rate is one of the most important variables of real estate market, since it
allows to convert the value of an owned home into a market rent and vice versa.
Alternatively, the real estate value can be estimated with a hedonic model by applying the
hedonic prices to the characteristics of the property[1]. Indeed, income capitalisation
approach and hedonic model are the two methods usually used in the real estate appraisals
(see e.g. Garner and Short, 2009). Precisely, property that is capable of generating rental
income, and for which an investor represents the most likely purchaser, warrants use of the
income capitalisation approach as the principal valuation model for ascertaining market
value(Sevelka, 2004, p. 135). Instead, when an enough number of transactions (sale prices)
is available, the hedonic approach is the most object method for estimating the market value
of a property (see e.g. Eurostat, 2013). Indeed, market value is a concept in economic theory Journal of Property Investment &
Vol. 37 No. 3, 2019
pp. 289-300
© Emerald PublishingLimited
DOI 10.1108/JPIF-11-2018-0088
Received 21 November 2018
Revised 15 January 2019
Accepted 15 January 2019
The current issue and full text archive of this journal is available on Emerald Insight at:
JEL Classification R21, R31, R32
The author is indebted to two anonymous referees for their many valuable comments and
suggestions that have significantly improved the paper.
method and
hedonic model

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