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
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.
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.
Comparable Sales Approach
The comparable sales approach estimates a property's value by comparing it to similar properties that have recently sold in the same market area. It is the most widely used and reliable approach for appraising residential properties.
Cost Approach
The cost approach estimates a property's value by calculating the current cost to rebuild the improvements, subtracting accumulated depreciation, and adding the land value. It is most reliable for new construction and special-purpose properties.
Reconciliation in Appraisal
Reconciliation is the final step in the appraisal process where the appraiser analyzes the value indications from all applicable approaches and arrives at a single final opinion of value. It is not a simple average of the three values.
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.
Frequently Asked Questions
Test Your Valuation Knowledge
Practice with exam-style questions to make sure you can apply Income Approach and other valuation concepts.