What is the "income approach" in property valuation?

The income approach in property valuation is centered on estimating the value of an investment property based on the income it generates. This method primarily applies to commercial real estate or rental properties, where the expected net income can be reliably forecasted. The underlying principle is that the value of a property is directly related to its capacity to produce income for its owner.

To implement this approach, an appraiser might calculate the property's rate of return by analyzing the net operating income (NOI) and dividing it by a capitalization rate (cap rate). The NOI considers all revenues from the property, such as rent, minus operating expenses. By analyzing expected future income and applying an appropriate cap rate, a reasonable value can be determined.

This method contrasts with other valuation approaches that rely on market comparisons or construction costs. Although those approaches hold significance in different contexts, the income approach specifically targets income generation as a key factor in determining property value.