Lesson 20 – Summary (The Income Approach to Value)
Income-producing real estate is typically purchased as an investment, and from an investor's point of view earning is the critical element of property value. An investor who purchases income-producing property is essentially trading present dollars for the expectation of receiving future dollars (from both an income stream and a reversion). Rule 8(a) says in part, "The income approach to value is used in conjunction with other approaches when the property under appraisal is typically purchased in anticipation of a money income and either has an established income stream or can be attributed a real or hypothetical income stream by comparison with other properties." The income approach to value consists of methods, techniques, and mathematical procedures that an appraiser uses to value an income producing property. If property is not being purchased for the benefits of the income it will produce, the income approach to value is probably not an appropriate tool to use in appraising the property.
Basic Assumptions of the income approach:
- People purchase property for the income or benefits it will produce.
- Investors estimate the quantity, duration, and quality of the anticipated income stream.
- A dollar today is worth more than a dollar in the future.
As we have discussed throughout this Self-Paced Online Learning Session, the income approach to value is based on these three premises. If the facts regarding the property being appraised do not correspond to these premises, the income approach should not be used. If the property meets the premises of the income approach, and if income and expense forecasts, remaining economic life estimates, and capitalization rates are accurate and supported by market data, the approach produces a supportable indicator of market value.
Summarizing the income approach:
The income approach includes any method of converting an income stream into an indicator of market value. 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 approach requires careful application because small variations in its key variables can be mathematically leveraged into a wide range of estimated value. The accuracy of the approach depends on the validity of the assumptions used to estimate its key variables. Mathematical techniques used in the approach, which are sometimes complex, are merely tools for converting these assumptions into an estimate of market value.
Although several appraisal principles are relevant to the income approach, the principle of anticipation is fundamental. The principle of anticipation states that value is created by the anticipation of future benefits, which leads in fact to one definition of value as the present worth of future benefits. All income capitalization methods and techniques are attempts to convert expected future benefits into an estimate of present value.
Four basic steps in the income approach
- Estimate gross income for the subject property.
- Process the income stream – estimate and deduct the allowed vacancy and collection losses and the expenses from potential gross income to obtain the income to be capitalized.
- Select the appropriate capitalization method.
- Apply the appropriate capitalization multiplier or rate to the income to be capitalized to generate a value indicator.
Fundamentally, income capitalization involves two processes:
- Deriving the rate or multiplier – these may be extracted from sales of comparable properties.
- Buyers anticipate income.
- Income after deduction of property taxes – NIBR for the OverAll Rate [OAR], and Net Income for Yield Rates
- Applying the derived rate or multiplier to value the subject property.
- Market (economic) Income.
- Income prior to any deduction for capital recapture or for the payment of ad valorem property taxes (NIBT); an allowance for the property tax is a component of the capitalization rate, if applicable. (Note: property tax is not an issue in multiplier analysis because the level of income used is prior to deducting for operating expenses.)
Two main types of income capitalization discussed in this course
- Direct capitalization, using multipliers and OverAll Rates.
- Yield capitalization, using the Building and Land Residual Techniques and the Property Reversion Technique.
Property Tax Rule 8, part of the California Code of Regulations, details the proper application of the income approach for the California property tax appraiser.
The BOE certified property tax appraiser who understands
- Property Tax Rule 8,
- the assumptions behind the income approach to value,
- the steps involved in deriving multipliers and rates, and
- the different methods of capitalization, and
Training Credit for Certified Property Tax Appraisers
If you are a certified property tax appraiser or auditor-appraiser working for a California county assessor's office or the State Board of Equalization, you can obtain training credit for taking this self-paced online learning session. If you wish to obtain training credit, you must complete the online Examination at the end of this learning session and submit your answers to the State Board of Equalization's County-Assessed Properties Division using the 'Submit' button at the end of the exam. You must also complete a separate timed proctored examination in order for the course to be counted toward meeting the advanced certification requirements. Upon successful completion of the course examination and the separate proctored examination you will receive 33 hours of training credit for the online examination and 3 hours for the proctored examination. Advise your County Assessor's Training Coordinator that you have completed this online learning session and they will make arrangements for the proctored examination.
By submitting the online examination, you are attesting to the fact that you have read all the lessons and have performed all the exercises in the "Check Your Knowledge" section of the training. Please do not share your answers to the Examination with anyone.