A procedure in appraisal analysis that
converts anticipated benefits (dollar
income) to be derived from the ownership of
property into a value estimate.
The income approach is widely applied in
the appraisal of income producing properties
through the use of either yield or direct
capitalization processes. This approach
assumes that there is a relationship between
the income that a property is capable of
earning and its value at any given time and
can be briefly summarized in five successive
steps.
Estimate the
potential annual gross income minus the
likely vacancies and bad debt.
Estimate the
total annual operating expenses.
Calculate the net
operating income.
Set the
appropriate capitalization rate.
Estimate the
value of the property based on the
selected capitalization rate.
The appraiser estimates the potential
annual gross income for the current year. A
market-derived vacancy and bad debt loss
allowance is subtracted from this to arrive
at effective gross income. Operating
expenses are deducted from the effective
gross income, leaving net operating income.
The appraiser selects and applies a rate and
method of converting the net operating
income into value by a mathematical process
called capitalization.
The yield method of capitalization,
while utilizing Steps 1, 2, and 3, requires
alternate steps in the determination of
operations cash flows (before or after tax),
for a specified holding period including the
reversionary value at point of sale (sale
proceeds before or after tax). The result is
discounted at an appropriate discount rate
to arrive at present value.
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