Income (Capitalization) Approach

The income capitalization approach to value is one of the three "approaches to value" that is based on the income generating capacity of a subject property property and on an appraiser derived capitalization rate.

The income approach utilizes direct capitalization, that includes the analysis of current year income and expenses, and a market derived direct market capitalization rate.  Yield capitalization considers the net present value of cash flows from established or anticipated leases and a reversion via a Discounted Cash Flow analysis model.

The income and expense figures used in and Income Approach can be based on pro-forma data, actual figures and forecasts.  Appraisers also distinguish between start-up income, income from properties that are not stabilized and income from properties that have been stabilized.

Direct market capitalization rates are usually established by appraisers via market research.  Annual net operating income (NOI) divided by the sales price of a building (or NOI / Sale Price) provides a direct market capitalization rate for comparison.  As always, it is important to compare the same building type and to keep other factors like location, size, building quality and floor area ratio (FAR) within reasonable bounds.

The income approach is most applicable to the appraisal of properties with cash flows that are purchased by investors.  The approach considers income producing properties from an investors perspective.  Properties, like single-family residential homes and land, that typically do not produce income are not analyzed using the income approach.  Commercial and industrial buildings, however, are usually bought and sold based on their income generating capacity and the income approach is often given the most emphasis or weight in their appraisal. 

The abstracting and analysis of leases can be simple or quite complex.  Leases often include a "base rental rate," some include a "percentage rate" that is tied to sales, some include an "overage rent" provision and most have rental rates that are tied to changes in the consumer price index (CPI).  Some leases offer "options" that can continue the term of the lease for several years into the future beyond its initial term.  Others owner / landlords build in fixed, long-term, upward adjustments without consideration for changes in market conditions.  The appraisal of commercial properties with 15 or more leases, each of them with different terms, different adjustment dates and different options can become a challenging and time consuming process for an appraiser.

In some cases income and expense information is not available, due to properties being owner-occupied, and appraiser must forecast an economic lease rate and appropriate expenses based on market information.

Contact us with your questions or concerns regarding the income approach or regarding your specific appraisal assignment in Nevada at 1-702-568-6699.  We can also be e-mailed at grigdon@cox.net.  

Commercial Real Estate Appraisals in the Las Vegas & Henderson, Nevada Area.