Income Approach Calculator Formula
Understand the math behind the income approach calculator. Each variable explained with a worked example.
Formulas Used
Indicated Property Value
property_value = noi / (market_cap_rate / 100)Net Operating Income
net_operating_income = noiEffective Gross Income
effective_gross_income = effective_incomeVariables
| Variable | Description | Default |
|---|---|---|
gross_income | Gross Annual Income(USD) | 60000 |
vacancy_pct | Vacancy Allowance(%) | 5 |
operating_expenses | Annual Operating Expenses(USD) | 18000 |
market_cap_rate | Market Cap Rate(%) | 7 |
effective_income | Derived value= gross_income * (1 - vacancy_pct / 100) | calculated |
noi | Derived value= effective_income - operating_expenses | calculated |
How It Works
Income Approach to Value
The income approach (direct capitalization) converts a property's income stream into a value estimate using a cap rate derived from market data.
Steps
1. Start with gross annual income 2. Subtract vacancy allowance to get effective gross income 3. Subtract operating expenses to get net operating income (NOI) 4. Divide NOI by the market cap rate to get property value
Formula
Value = NOI / Cap Rate
Worked Example
A duplex generates $60,000 gross income, with 5% vacancy, $18,000 expenses, and a 7% market cap rate.
- 01Effective gross income: $60,000 x (1 - 0.05) = $57,000
- 02Net operating income: $57,000 - $18,000 = $39,000
- 03Property value: $39,000 / 0.07 = $557,143
Frequently Asked Questions
When is the income approach used?
The income approach is primarily used for income-producing properties like rentals, apartments, and commercial buildings. It is less useful for owner-occupied homes that do not generate income.
Where does the cap rate come from?
The market cap rate is derived from recent sales of comparable income-producing properties by dividing their NOI by their sale price. It reflects the return investors expect in that market.
What expenses are included in operating expenses?
Operating expenses include property taxes, insurance, management fees, maintenance, utilities (if owner-paid), and reserves. They exclude mortgage payments and depreciation.
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