Journal of Real Estate Finance and Economics, 23:1, 47±76, 2001
# 2001 Kluwer Academic Publishers. Manufactured in The Netherlands.
A Present-Value Model of Real Estate with
Interneighborhood Dependency of Incomes
Faculty of Economics, Kagawa University
Graduate School of Decision Science and Technology, Tokyo Institute of Technology
In this article, we build a simple present-value model to give the basis for an income-capitalization appraisal
method considering interneighborhood dependency of net operating incomes. We also show the maximum-
likelihood estimation method for the model in a cross-sectional situation and apply them to the residential land
market in the Tokyo Metropolitan Area in the period 1986 to 1998. The results partly provide realistic estimates of
the parameters and show the applicability of our model.
Key Words: present-value model, interneighborhood dependency, NOI stream, spatial econometrics, SARMA
The income capitalization approach is a well-established and widely accepted one for real
estate appraisal. In Japan, however, this approach has not been regarded as important and
has not been used enough in practice until quite recently. Many researchers, appraisers,
and policy makers have started paying attention to its use nowadays. One reason for such
increasing interest in this approach is that they think the land-price bubble in the late 1980s
in Japanese metropolitan areas was partly due to the conventional appraisal method mainly
based on the sales comparison approach. Another reason is that they need the globally
standardized appraisal methods to get a great deal of investments from foreign countries
and revitalize Japanese real estate markets. Therefore, many Japanese have begun to
consider the income-capitalization approach more rational and useful.
In the United States, the income-capitalization approach has been already systematized.
It has also played an important role in the practical side of appraisal. In fact, according to
the various editions of The Appraisal of Real Estate (Appraisal Institute; ®rst edition 1951,
eleventh edition 1996), this approach has been remarkably developed. The development of
the Ellwood method and the appearance of discounted cash ¯ow (DCF) analysis are
signi®cant. Improvements in computer performance accelerated their use.
All existing methods in the income-capitalization approach, however, do not explicitly
consider interactions between changes in one neighborhood (or district) and those in
others. It is especially necessary to take account of interneighborhood dependency of net
operating incomes (NOIs) in real estate appraisal, but the present income capitalization