Professional Activity: Income Approach

There are three different approaches Appraiser's use when determining a property's value. They consist of the income approach, the cost approach and the sales comparison approach. The cost approach is generally used for new construction or special buildings such as schools or churches. The sales comparison approach bases the appraisal off current sales. This approach is most effective in a market that is moving similar properties frequently. Finally, the income approach is used for investment properties including commercial real estate. The income approach consists of several important steps that must be used in order to accurately assess a property's value.

The first step in the income approach for commercial properties is calculating Potential Gross Income (PGI). PGI can be calculated by multiplying the number of units by the current market rent. In commercial real estate, it may be hard to determine current market rent because comparable properties are hard to find. The present rental income collected from the property may not reflect the potential market rents. This forces appraisers to study the market to obtain accurate rent information.

Next, the appraiser must calculate effective gross income (EGI). Before they calculate EGI, they must estimate the vacancy rate. This estimation comes from the rental information based on the market. Subsequently, annual operating expenses must be deducted from EGI to provide you with the Net Operating Income (NOI). Appraisers can progress to the next step once NOI is calculated accurately.

The overall capitalization rate can be found by dividing NOI by the purchase price (PP). The Capitalization rate is typically used for income producing properties and used to estimate the value of the investment. Once the appraiser feels the capitalization rate is accurate, they divide NOI by the capitalization rate. This final calculation gives the investor a value of the property. Many appraisers believe this last step to be the most difficult in the income approach. They must have a complete understanding of the market in order to deliver an accurate capitalization rate and overall value of the property.

The income approach is an important element in appraising income producing properties or investment properties. It is rarely used in appraising single family homes as commercial real estate is more commonly used as an investment property. Although, the income approach may seem easy to analyze you must have reliable information and a complete understanding of the market in order to perform an accurate appraisal.
References
LeBovidge & Perry. "Why Is the Income approach used to Value?" June 2005. Retrieved May 7, 2011. http://www.mass.gov/Ador/docs/dls/publ/ct/2005/june.pdf
Commercial complete. Retrieved May 8, 2011. http://www.realestatevaluationsoftware.dcfsoftware.com/Lease%20Income%20Narrative.pdf
Realtown Words. Retrieved May 7, 2011. http://www.realtown.com/words/income-approach
Diaz & Hansz. "Real Estate Analysis: Enviroments and Activities" Kendall Hunt 2010.