The income approach is often given primary emphasis when appraising a commercial real estate used to generate income. Estimates of value via the income approach are highly sensitive to changes in revenue, expense and capitalization rates.Correctly performing a cost approach analysis appears to be and is technically difficult. It appears easy to correctly prepare an income approach analysis for commercial real estate. However, correctly preparing the analysis requires three criteria: 1. an understanding on the type of value, 2. accurate data, 3. accurate application of the income approach.Commercial income properties can be valued based on the leased fee estate. The fee simple estate is appropriate for properties with leases consistent with market rent and terms. Valuation of the leased fee estate is more appropriate for properties with above market or below market rents. Valuing properties with below market rental rates based strictly upon its actual rental rates would understate its value. Valuing it using market rental rates would overstate its market value.
Accurate data is the basis of a reliable income approach conclusion. This includes information on rental rates, occupancy rates, new construction, absorption, operating expenses and capitalization rates. Rental rates are usually obtained from rental comparables, subject property leases and aggregate market data. The same is true for occupancy rates. New construction can be obtained from personal observation while doing fieldwork, research and aggregate market data.Operating expenses are evaluated on a line-item by line-item basis.
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