Income Approach

Appraisers use the income approach to put a value on a property from the money it earns. Its direct capitalization form divides net operating income by a market cap rate. It is the method that gives real-estate NOI its standard definition, including a replacement reserve as an operating expense.

An appraiser using the income approach rebuilds the income statement from scratch: market rent, a vacancy allowance, then every expense the property carries. On the default house, that produces $45,600 of effective gross income, $16,708 of expenses and $28,892 of NOI. Capitalized at 6.5%, the property is worth $444,492. The Wikipedia article covers the reserve convention and the yield capitalization variant that projects NOI over several years.

The method is only as good as the NOI behind it. A pro forma that leaves out management and reserves lifts NOI by about $5,900 on this house and value by $91,000 at the same cap rate. Appraisers add those lines back, which is why an appraised value often lands below a seller's asking price on a small rental.