Income Approach

This is the third installment of our series on the various methods used by real estate appraisers to determine property value. Last week, we discussed the sales comparison approach and the cost approach. This post will focus on the income approach.

The income approach generally is used to estimate the value of income-producing properties, including office buildings, hotels, warehouses, apartment buildings, and shopping centers. It is a method of appraising real estate based on the property’s anticipated future income.

The income approach, which is often viewed as the most reliable of the three approaches, is used when reliable financial data is available for recent sales of similar income properties in a given marketplace. The expected annual income of a property is divided by the capitalization rate to determine the market value of a property.

• The capitalization rate is calculated by a property’s net operating income and sales price for the sale of similar properties in a given area or marketplace. If sales of similar income properties in the area can be determined, one can establish a market capitalization rate by averaging the capitalization rate values of area sales.

• To determine the expected annual income of a property, an appraiser first estimates the annual potential gross income for a property, which includes how much rent each unit could generate in the market. The estimates of potential rental rates are generally derived from the current marketplace. The effective gross income for a property is generated by reducing the annual potential gross income by a vacancy allowance amount, which is determined by current market rental conditions for the type of property being analyzed. Additional income is added to the income estimates, including parking fees, laundry fees, and other profit-generating variables. Operating expenses are deducted from the effective gross income to determine the annual net operating income for the property.

It is important to note that when there is insufficient financial data for similar properties in a given market, appraisers may use all three appraisal approaches that we covered over the last three blog posts.

By: Present Value

Tags: cost approach, Income approach, Income Property, present value, Real Estate Appraisal, sales comparison approach
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