Being one of the most widely implemented valuation methods, the income approach analyzes the expected economic benefits that investors anticipate from a real estate investment. The method discounts the property’s expected cash flows in their present value using the capitalization rate of the property.
The capitalization rate represents the risk of investment and is calculated based on a property’s Interest before Depreciation, Interest, and Taxes (IBDIT) considering the current interest rate on the property’s mortgages, the equity investment in the property, and a risk factor to reflect the real estate investment risks.
In a nutshell :
- The income approach is a real estate valuation method that uses the income the property generates to estimate fair value.
- It's calculated by dividing the net operating income by the capitalization rate. A buyer should pay special attention to the condition of the property, operating efficiency, and vacancy when using the income approach.