Agricultural Economics Department
Farmland Valuation: Understanding Income Capitalization and Cap Rates
Date of this Version
6-19-2024
Document Type
Newsletter Issue
Citation
Cornhusker Economics (June 19, 2024)
Agricultural Economics, University of Nebraska–Lincoln
Abstract
The income capitalization approach is likely the most challenging and least understood of the three methods that farm appraisers use to inform their opinion of value. In theory, the approach is relatively simple: the income value of a parcel of farmland is simply the present value of the farmland’s perpetual stream of net operating income. However, as with many economic approaches and concepts, the devil is in the details. The word perpetual is intentional as the income approach uses the formula for a perpetuity, namely, V = N/c, where V = income value, N = net operating income, and c = capitalization rate, or cap rate for short. While there are several important assumptions and some requisite mathematical gymnastics to arrive at the perpetuity equation for the income value of farmland, in this article, we’ll concentrate on the numerator of the equation, N, and, more importantly, the denominator, c.