The income approach is a valuation method that estimates a property's value based on the income it generates or is capable of generating, converting anticipated future income into a present value indication. It is one of three recognized approaches to value, alongside the sales comparison and cost approaches.
In practice, the income approach is most applicable to rental properties, multifamily housing and investment real estate where buyers make purchasing decisions based on income potential. Appraisers typically apply this method using either direct capitalization, which divides net operating income by a market-derived cap rate, or discounted cash flow analysis for more complex income-producing properties.
For residential appraisals, the income approach carries the most weight when the subject property is tenant-occupied or located in a market where rental activity drives buyer behavior. Loan originators and underwriters should understand that income approach conclusions are only as reliable as the rental data and capitalization rates supporting them.