Appraisal Valuation Process Income Approach IV
This post follows three other posts in a series: What Is An Appraisal I, What Is The Appraisal Valuation Process Sales Comparison Approach II, and Appraisal Valuation Process Cost Approach III.
In this appraisal approach the value estimate is placed on a properties ability to generate income. Generally used for larger income producing properties such as office buildings or malls, larger apartment buildings, commercial properties.
There are five steps used in the Income Approach:
The potential gross income; this step estimates not only the expected rent, but also income from other sources on the property such as vending machines. The rent estimate is calculated from market rent rather than current rents in the subject property. The Effective Gross Income is an estimate of expected vacancies and uncollected rent and is deducted from the potential gross income. The Net Operating Income (annual) is cost of operation and includes, but not limited to: Real Estate taxes, insurance, maintenance, legal counseling, utilities, etc. This amount is deducted from the effective gross income. The Capitalization Rate is the rate of return. The capitalization rate or CAP rate is estimated by comparing the net operating income with sales prices of comparable properties. Cap rates are determined by dividing the net income of a property by its sales price. In the last step to Estimate The Properties Value, the cap rate is applied to the subject properties net operating income. That is by dividing the net income by the cap rate which equals the estimated value of the property.
Two more simplistic alternative's to the income approach are the Gross Rent Multiplier and the Gross Income Multiplier. Where residential rental properties are concerned the gross rent multiplier is used because single family homes or smaller multi-family (2-4 units) homes do not usually have income outside of rent. To determine the GRM the sales price of comparable properties are divided by the gross monthly rent. The result is a number that is multiplied by the subject properties fair market rent to estimate its value. The Gross Income Multiplier (GIM) is determined the same way, but includes other sources of income on an annual basis and therefore is better suited to larger apartment buildings and commercial property. The shortcoming of these last two approaches is in their simplicity as operating expenses are not considered.
As stated before, these last few posts about the appraisal process is only meant to acquaint the casual reader with the very basics of property appraisal.
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