While this approach can usually be considered to be a reliable approach to value, there are inherent weaknesses. No two properties are identical. The lack of any sales activity, or rental activity of similarly property types will result in a limited data base from which to draw conclusions. The availability of abundant data for comparison allows the appraisers to choose comparable properties that require fewer adjustments which reduces the chance for error. The Income Approach to Value can be applied to a specified parcel of real estate utilizing either a gross rent multiplier or a true income analysis based upon economic rent and/or contract rent and a reconstruction of the operating statement as of the date specified. This, then, becomes an indication of net annual income, which is capitalized into a value indication. A property capitalization rate considers such things as current financing terms, equity investment requirements, as well as equity expectations on dollar returns which are best supported by direct market data.
In the appraisal of residential property, typically the Income Approach is based upon a gross rent multiplier technique, which is a ration of value arrived at by dividing the known sale price by the known rental of a specific property.
Paired sales analysis can also be utilized in arriving at a gross rent multiplier indication. This often occurs where there is little or no resale activity of single family rental property. After arriving at an estimate of market rent and an estimate of the applicable gross rent multiplier, an indication of value by the Income Approach utilizing the gross rent multiplier technique can be supported.
If the subject property in question is truly one that is bought and sold based upon its income earning potential, then the Income Approach becomes a very pertinent and reliable approach to value if sufficient supporting market data is available and analyzed.
It is emphasized that all three approaches to value are premised upon the principle of substitution. Each parcel of real estate is typically considered upon its own merits and all three approaches are not necessarily applicable to any one specific property at any one point in time. This is a judgment by the appraiser after analyzing the subject property and considering the data deemed pertinent for comparison purposes. After analyzing this data and selecting the appropriate approach or approaches to value, the appraiser must then correlate the various value indications into a final estimate of value. This is typically considered as the reconciliation portion of the appraisal and is usually based upon that approach which has proven to be the most reliable for the subject type in question and is the approach in which the appraiser has the greatest confidence of market support.