The income capitalization approach

Income becomes value

The income capitalization approach estimates the value of income-producing real estate from its expected earning power. It applies anticipation: buyers pay for future benefits. It is particularly useful for rented apartments, offices, and shopping properties with reliable income and market evidence.

Build the income estimate

Start with annual potential gross income at full occupancy. Subtract vacancy and collection losses and add other income to obtain effective gross income. Subtract property operating expenses to obtain net operating income, or NOI. Operating expenses include property taxes, insurance, management, maintenance, and owner-paid utilities. Exclude debt service, owner income taxes, and accounting depreciation. Treat replacement reserves consistently with the capitalization rate's income definition. Use stabilized estimates rather than assuming temporary full occupancy or unusually low expenses will continue.

Capitalize net income

Value = annual NOI ÷ capitalization rate. Express the rate as a decimal. Rearranging gives rate = NOI ÷ value and NOI = value × rate. Derive rates from comparable market evidence using consistent income definitions; a capitalization rate is not simply a mortgage interest rate.

For example, $120,000 potential gross income minus $6,000 vacancy and collection losses plus $2,000 other income equals $116,000 effective gross income. Subtract $36,000 operating expenses to obtain $80,000 NOI. At 8%, value is $80,000 ÷ 0.08 = $1,000,000.

Holding NOI constant, a higher capitalization rate lowers value. Holding the rate constant, higher NOI raises value. A gross rent multiplier uses gross rent without subtracting operating expenses; match the rent period to the multiplier. Discounted cash flow analyzes multiple future cash flows and resale proceeds instead of capitalizing one year's stabilized NOI.

Florida assessment connection

Florida section 193.011(7) makes property income one factor in just valuation. For qualifying low-income housing tax credit property, section 193.017 excludes tax credits and financing generated by them from income and recognizes actual rental income from rent-restricted units. These assessment rules do not require direct capitalization in every market appraisal.