Income approach

Question 1

What is the income approach?

Answer 1

Measure a flow of income projected into the future

The income approach is a method used in real estate to determine the value of a property based on its ability to generate income.

Question 2

What is the principal of anticipation?

Answer 2

Value is created by the expectation of an income stream into the future

This principle emphasizes that the potential future income from a property affects its current value.

Question 3

What are the steps in the income approach?

Answer 3

• Estimate annual potential gross income (PGI)
• Deduct vacancy and collection loss & add other non-rental income to derive effective gross income (EGI)
• Deduct operating expenses (fixed, variable, and reserves for replacement) to derive net operating income (NOI)

These steps provide a systematic method for calculating the value of an income-producing property.

Question 4

How do you get effective gross income (EGI) from the potential gross income (PGI)?

Answer 4

Deduct vacancy and collection loss & add other non-rental income to PGI to derive EGI

EGI represents the actual income expected from a property after accounting for potential losses.

Question 5

How do you get net operating income (NOI) from effective gross income (EGI)?

Answer 5

Deduct operating expenses (fixed, variable, and reserves for replacement) from EGI to get NOI

NOI is a key metric used to evaluate the profitability of an income-generating property.

Question 6

How do you calculate the cap rate?

Answer 6

• NOI % value = cap rate
• Use the NOI of properties similar to the subject property
• Divide each NOI by the property’s sales price

The capitalization rate is used to estimate the return on an investment property.

Question 7

Once you have the value, what do you do?

Answer 7

Reconcile the value indications into a final value estimate - weighted average

This process ensures that different valuation methods are considered to arrive at a final value.

Question 8

What is the formula using I, R, and V?

Answer 8

• I = NOI
• R = capitalization rate
• V = value (or sales price)
• V = I / R

This formula is fundamental in real estate valuation, linking income, capitalization rate, and value.