Appraisal Income Approach
In the appraisal world, the income approach, sometimes called the capitalization approach, is one of the most widely used approaches to determine value for income producing or investment properties. The income approach is relevant for appraisal assignments in which the subject property is leased, or could be reasonable leased, producing an income stream for the owner. Properly performed, it can provide a firm foundation for an opinion of value. The income approach estimates the value of real estate by analyzing the amount of revenue or income the property currently generates, or could generate.
While the income approach is an objective appraisal method for evaluating data, there’s room for subjectivity in arriving at some of the numbers used in the evaluation. Income and expenses are based on past numbers – vacancy and collection losses are derived from market data – but different investors may have different rates of return they require on their investments. This can lead to different opinions of value for the same property.
Market value is the theoretical price that a piece of real estate is most likely to bring in, in a typical transaction. A typical transaction, also called an “arm’s length transaction”, is one in which the transaction occurred under typical conditions in the marketplace where each of the parties were acting in their own best interests. When evaluating commercial property, the goal is to determine what a particular investor is willing to pay for the property.
Capitalization Rate (Or Cap Rate) Overview
The capitalization rate (or Cap Rate) is a percentage rate used by investors to calculate the present value of future income. We’ll use the capitalization rate, or cap rate, to estimate the value of real estate. This rate is essentially equal to the rate of return an investor would expect to earn in a real estate investment. Since the capitalization rate for a real estate investment is not guaranteed, an investor will expect a larger rate of return than he or she can get from safer investments.
The primary thing that a potential investor needs in order to estimate the value of a real estate investment is the net operating income.
If you have any questions about cap rates, or if you are curious how much your commercial property is worth, feel free to Contact Us anytime.