Risk assessment in estimating the capitalization rate

In estimating the market value of a property by income approach, the determination of the capitalization rate is ordinarily conducted through analogical process. The procedure is based on the identification of price-earnings ratio of similar investments. The analogy refers to the risk and the duration of the investment. However, in all cases there still remains a rate of uncertainty that significantly affects the final estimation of the property. This paper proposes a methodology which removes any uncertainty when evaluating the cap-rate. The aim is achieved through the combination of the formal logic of the Ellwood’s model and the Real Options Analysis. The algorithm developed has been applied to a sample relative to 57 Italian cities, considering annual prices from 1967 to 2012. The results highlight the validity of the model and the easiness of use. The work must be attributed equally to the three authors. Key-Words: Ellwood, Real Options, cap-rate, risk, real estate, investment.