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The Income Method of Real Estate Appraisal and Valuation

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This method is used for income properties:

If a property's use is to be to generate income from rents or leases, the income method of appraisal or valuation is most commonly used. The net income generated by the property is used in conjunction with certain factors to calculate its value on the current market if sold.

Using Capitalization Rate (cap rate) to estimate value:

When using capitalization rate to value an income property, the net operating income of the property is used, and there is an inverse relationship between the asking price and cap rate. In other words, the higher the cap rate, the lower the asking price.

Using cap rates from both buyer and seller perspectives.

Using Gross Rent Multiplier for value estimate:

Gross Rent Multiplier or GRM uses the gross rentals of a property rather than the net operating income used with cap rate. There are two ways to do this calculation, as there is Gross Potential Income (GPI) and Gross Operating Income (GOI). As can be seen from the calculations of each, the value estimate is much better using Gross Operating Income, as losses for occupancy and non-payment are considered.

Then Condition and Future Expenses Must be Considered:

More subjective, but very important, is taking the property condition into account. As neither of the income valuation methods consider condition and future probable large repair expenses, those must be considered in arriving at a final estimate of value.

Know the Income Method, as It's Used a Lot:

If you plan on working with investor clients, spend significant time if necessary in order to learn the income method of valuation. You don't want your investor buyer or seller clients to use terminology that you don't recognize or ask for calculations you can't perform.

Working with investors can be quite rewarding, as this niche real estate market is quite active. You will also build great repeat business as well as referrals from satisfied investor clients. **Update: I'm updating this article after the real estate market crash and during what appears to be the beginning of a recovery. Appraisers became extremely conservative after the market problems and have been blamed for slowing the recovery by under-valuing properties and using foreclosures for comparables. However, they seem to be getting back on an even keel now.

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