The Income Approach

The Income Approach estimates value based on the property’s ability to generate future income. It relies on the Principle of Anticipation—the idea that value is created by the expectation of future benefits. The goal is to convert the property's income stream into a present lump-sum value using a capitalization rate.The appraiser starts by estimating the Potential Gross Income (PGI), which is the maximum rent the property could generate if it were 100% full. They then subtract vacancy and collection losses to find the Effective Gross Income (EGI). From the EGI, they subtract all operating expenses (fixed expenses like taxes, variable expenses like utilities, and reserves for replacements like a new roof fund) to arrive at the Net Operating Income (NOI). The NOI is the most critical number in this approach. Finally, the appraiser divides the NOI by an Overall Capitalization Rate (Cap Rate) to determine the value. The formula is NOI ÷ Cap Rate = Value (often remembered as I ÷ R = V).This method is essential for income-producing investment properties, such as apartment complexes, office buildings, and shopping centers.