Build-up Method

Definition 1(Real estate):
R₀(BU) = pure rate + liquidity premium + recapture premium + risk premium

R₀(BU): capitalization rate under the build-up method

pure rate: (e.g.)the interest rate on U.S. government bonds after adjustments for real estate based tax savings
liquidity premium: (e.g.)the premium investors require for the illiquidity of real estate investments
recapture premium: (e.g.)the average real estate return net of appreciation
risk premium: (e.g.)the real estate investment risk premium

• The build-up method is usually applied to closely held companies where betas are not readily available.

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Definition 2(Equity):
R₀(BU) = risk-free rate + equity risk premium + size premium_i + specific-company premium_i

R₀(BU): required return on equity under the build-up method

Following adjustments are not usually made in the required return on equity calculation, but rather directly to the estimated value:

• Control premium
• Marketability premium

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Definition 3(Equity):
R₀(BU) = risk-free rate + equity risk premium + small stock premium_i + company-specific risk premium_i + industry risk premium_i

industry risk premium_i: used instead of beta

R₀(BU): required return on equity under the build-up method