Real Estate Appraisal

Real estate appraisal is the practice of estimating what a property is worth. For income property, the appraiser's income capitalization approach rebuilds net operating income line by line and divides it by a market cap rate. NOI as investors use it is an appraisal construct, and appraisal standards define its lines.

An appraisal of the default house would confirm market rent near $2,500, apply a vacancy allowance, then list taxes, insurance, management, maintenance and reserves whether or not the seller reports them. The result, $18,270 of NOI, is capitalized at the rate recent sales in the area support. At 6.5% that is $281,077, and a lender will size the loan off that figure rather than the $300,000 contract price.

Appraisers also run the sales comparison approach and, for new construction, the cost approach, then reconcile the three. On a single-family rental the sales comparison usually controls. On a fourplex or larger, the income approach carries more weight, so the NOI you can document is the value you get. The Wikipedia article describes all three approaches and the reconciliation step.

Further reading: Real Estate Appraisal on Wikipedia.