Understanding the Income Approach to Property Valuation

Posted on Sep 19 2017 - 1:00am by Business Day TV

Man with his property valuation sketchIf you’re planning to invest in rental property, you should consider using the income approach to valuation. The latter is the method commonly used by agencies and appraisers. Along with the generated net income of a property, experts consider other factors to determine its value in the marketplace if sold.

Americashousingalliance.com and other experts on real estate investment management cite the following methods that the income approach includes in its valuation.

Cap Rate

When you apply the capitalization rate in determining the value of real estate, one of the values you use is the net operating income of the property in question. Note that an inverse relationship exists between the capitalization rate and the listed price. Put simply, the higher the asking price, the lower the cap rate and vice-versa.

Gross Rent Multiplier

The gross rent multiplier (GRM) uses gross rentals of real estate instead of net operating income when calculating the projected value. The two ways to calculate the result are gross operating income (GOI) and the gross potential income (GPI).

Agents and appraisers prefer using the former because it accounts for non-payment and occupancy losses. These two approaches provide you with insights whether or not you’re making a good investment on a piece of property. The projections enable you to determine the profitability of properties on your short list.

Condition and Future Expenses

The above-mentioned income valuation models don’t account for the condition of the property and the potential expenses for repairs and renovations. You must factor in future and probable costs you may incur when calculating the estimate. Before investing, monitor the operations of the property and ask yourself a few questions such as:

  • Does the current landlord maintain the spaces regularly?
  • Do the tenants take care of the spaces given to them?
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You have to calculate the value of a property based on certain methods such as the income approach, but you also need to factor in the daily operations to get a good estimate of the real estate you want to invest in.