Income Approach
Definition
The income approach estimates a property's value based on the income it generates by converting net operating income into a value estimate using a capitalization rate. It is the preferred method for income-producing properties.
Example
An apartment building generates $200,000 in potential gross income. After deducting 5% for vacancy ($10,000) and $90,000 in operating expenses, the NOI is $100,000. Using a cap rate of 8%, the value is $100,000 / 0.08 = $1,250,000.
Exam Tip
The income approach formula (Value = NOI / Cap Rate) is essential. Remember that mortgage payments and income taxes are NOT operating expenses. Know the inverse relationship between cap rate and value—as the cap rate decreases, value increases.
Related Valuation Terms
Real Estate Transfer Taxes
A transfer tax is a tax imposed on the transfer of ownership of real estate.
Property Tax Exemptions and Relief Programs
Various programs and exemptions exist to reduce the property tax burden for specific groups, such as seniors, homesteaders, or veterans.
Depreciation of Investment Property
Depreciation is an accounting method of allocating the cost of an asset over its useful life, allowing investors to deduct a portion of the asset's cost each year.
Property Tax Assessment Limits
Many states have laws to limit how much property taxes can increase each year, regardless of market value fluctuations.
Homestead Portability
Homestead portability allows homeowners to transfer a portion of their accumulated homestead tax savings to a new homestead in the same state.
Highest and Best Use
Highest and best use is an appraisal concept that identifies the most profitable, legally permitted, physically possible, and financially feasible use of a property. It is the foundation of all property valuation.
Frequently Asked Questions
Test Your Valuation Knowledge
Practice with exam-style questions to make sure you can apply Income Approach and other valuation concepts.