Lesson 3 Exercises - Assumptions of the Income Approach (The Income Approach to Value) (2024)

FAQs

What are the assumptions of the income approach? ›

The income approach assumes an investor will not pay more that the cost of making an equally profitable investment, assuming equal risks. The comparative sales approach assumes a buyer will not pay more for a property than the cost of buying a similar property.

Example of the Income Approach

After calculating the capitalization rate, the investor can divide the rental property's NOI by that rate. For example, a property with a net operating income (NOI) of $700,000 and a chosen capitalization rate of 8% is worth $8.75 million.

The income approach is also called the capitalization approach because capitalization is the process of converting an expected income into an indicator of market value.

The process of converting periodic income into a value estimate is referred to as income capitalization. Income capitalization models can generally be categorized as either direct capitalization models or discounted cash flow models.

There are four fundamental accounting assumptions that form the foundation of financial statement preparation. These are: economic entity, going concern, monetary unit, and periodicity.

In the income approach, the method used to convert a single year's income into an estimate of property value. This can be accomplished by dividing the net operating income by a market-derived overall capitalization rate or by multiplying the income by a market-derived income multiplier.

There are three internationally accepted methods of measuring the value of property: the cost approach, the sales comparison approach and the income approach. Depending on the nature of the property being valued, one or more of the approaches may be used by the assessor.

There are three primary income approach methods: The direct capitalization cash flow method, the discounted cash flow method, and the gross income multiplier.

Capitalization is any method used to convert an income stream into value. There are two primary income capitalization methods: direct capitalization and yield capitalization. (A capitalization rate is any rate used to convert an estimate of future income into an estimate of market value.

When using the income approach, appraisers assume that? ›

They will estimate the quantity, quality, and duration of the future income. The income approach assumes that the investor in real property will estimate the duration of the income stream and its risk, or likelihood of receipt, when selecting a capitalization rate to value the property.

The income approach formula to determine the market value of a property is as follows. Where: Market Value = Net Operating Income ÷ Capitalization Rate.

The NOI approach is based on following assumptions: (i) There are no corporate taxes. (ii) Cost of debt remains constant at all level of debt. (iii)Overall cost of capital remains constant.

The income approach assumes that the investor in real property will estimate the duration of the income stream and its risk, or likelihood of receipt, when selecting a capitalization rate to value the property.

The assumptions are the following: The price level is fixed. Suppliers will supply any level of output that is demanded at the fixed price level. There are no government expenditures or net exports.