We’ve been discussing the three main real estate valuation approaches, the sales comparison approach, the income approach, and the cost approach. Today let’s continue with the second real estate valuation style which is the income approach. As I told you in my last post each style uses real estate comps to deliver information.
The income approach is typically used for income properties. The basic theory is that investors purchase income properties for the income stream they produce. This income stream can be converted to an indication of market value for the property. The primary steps in the income approach are to estimate the potential gross income using rent comparables and information regarding actual income at the subject property. An allowance for vacancy is estimated based on the performance of the subject property and average vacancy in the area. Operating expenses are estimated using actual expenses at the subject property and market expenses for similar properties. The net operating income is calculated by deducting vacancy and operating expenses from the potential gross income. Net operating income is converted to an indication of market value by dividing it by the capitalization rate.
I hope this information on income approach of RE valuation arms you with solid knowledge to succeed as you work with different investment properties and strategies. Tomorrow I will get into the last real estate valuation style, the cost approach.