Income Approach

 

              Appraisers use three different methods to estimate the value of real estate.  They

              are the income approach, the sales comparison approach and the cost approach.

              The sales comparison approach is considered the best method for appraising single

              family homes.  The cost approach is used to appraise special purpose buildings such 

              as churches, schools and public buildings.  The income approach is used to estimate 

              the market value of income producing properties such as office buildings, warehouses,

              apartment buildings and shopping centers.  When  adequate financial data for recent

              sales of similar income producing properties is unavailable, appraisers may use a

              utilize all three approaches.

 

              The following is a brief and simplified summary of the income approach.  The income

              approach is used when reliable financial data is available for recent sales of similar

              income properties in a given market place.  A properties net operating income and

              sales price are used to calculate a capitalization rate for the sale of each similar property  

              in a given area or market place.  If sufficient sales of similar income properties are

              available, a market cap rate can be determined by averaging the cap rate values

              from the individual sales.  Appraisers will sometimes use a market gross rent

              multiplier or gross income multiplier instead of a cap rate to estimate the value of   

              single-family rentals and 2 units. 

 

              Net operating income is calculated like this.

 

              1)  The appraiser first estimates the annual potential gross income for a property.

                   This involves estimating how much rent each unit could generate in the current

                    market place.  The rental rates being charged by the current owner may be too

                    low and may not reflect potential market rental rates.  Appraisers study the

                    current market place to estimate potential rental rates.

 

              2)  The appraiser then calculates an effective gross income for the property by

                    reducing the annual potential gross income by a vacancy allowance amount.

                    The vacancy allowance amount is determined by current market rental

                    conditions for the type of property being analyzed.

 

              3)  Miscellaneous income such as parking fees, laundry and vending receipts are

                   added to the income.

 

              4)  Operating expenses are deducted from the effective gross income to determine 

                   the annual net operating income for the property.  

 

 

        Income

   

            Gross Rents Possible       100,000

            Other Income                        3,000

        Potential Gross Income       103,000

            Less Vacancy Amount         2,000

        Effective Gross Income       101,000

            Less Operating Expenses 31,000

        Net Operating Income            70,000

 

              Once the net operating is determined, a capitalization rate is calculated for the property.

              If the above property sold for $670,000 , the cap rate is calculated like this.

 

                                                                         NOI                       70,000

                        Capitalization  Rate  =     ----------------     =   ---------------    =  .1045  X  100   =   10.45  Rounded

                                                                    Sales Price             670,000       

 

              We have several other similar income properties that the have recently sold in the same

              area.  There financial data is summarized below.

 

    Comparable No.     Sales Price    Net Operating Income  Capitalization Rate

               1                     670,000              70,000                          10.45

               2                     730,000             75,000                           10.27

               3                     625,000             65,000                           10.40

               4                     705,000             77,000                           10.92

               5                     780,000             80,000                           10.25

 

              We calculate a market cap rate by averaging the individual cap rate data.  The market       

              cap rate for the above data equals 10.46 rounded.  The appraiser would estimate the

              value of a similar income property like this.  He would go through the procedure above to

              calculate the net operating income for the property in question.  Lets assume that the

              net operating income is equal to 73,000.  He would use the following formula to calculate

              the market value

 

                                                                               Net Operating Income              73,000

                          Estimated Market Value  =     ------------------------------     =      ----------     =   $697,897

                                                                                Capitalization Rate                   .1046

 

              It should be noted that recent sales of similar property types may be unavailable or very

              infrequent.   For example, it may be difficult to calculate a market cap rate for shopping

              centers since there may be no recent sales.

 Tien and Jim 

Your Real Estate Partners