Build-up method for capitalization rate: Revisited

Purpose: The purpose of this paper is to revise the imprecise formulae of the risk build-up method widely used in the practice of property valuation, in particular, in unstable economies. Design/methodology/approach: This paper’s approach is the selection of the risk-free rate in the capitalization rate in the absence of exchange statistics. The equation of returns by analogy with Fisher (1907) and Fisher (1930) is used as a methodological instrument for this. Findings: This study presents exact formulae for build-up method and proposes a set of risk premiums independent of each other. Cases of investments in foreign and local currencies are considered. Research limitations/implications: To determine the values of risk premiums and the asset risk amendment with acceptable accuracy, a sufficient amount of statistical data about the market of the valuated property is required. Practical implications: The application of the build-up method in the revised form will allow for more accurate property valuation, especially in countries where the market is opaque or where there is not a lot of activity. Social implications: The departure from the original version of the build-up method with empirical “justification,” which after more than 30 years of application has become almost universally accepted, indicates a certain maturity of the valuation theory and will allow more effective appraisal of property, such as capital real estate or business. Originality/value: This paper is an original study based on the application of the equation of return to clarify the structure of the capitalization rate. When determining the proposed set of risk premiums, one of the principles of real estate valuation was used – the principle of dependency.