Which approach to value involves the use of a capitalization rate?

The income approach to value is centered around the concept of generating income from a property. This method is particularly relevant for investment properties, such as multi-family housing or commercial real estate, where income generation is a primary concern for investors. In using this approach, appraisers estimate the potential earnings of the property, which are then capitalized to determine its present value.

Capitalization involves applying a capitalization rate, which is a ratio used to convert income into an estimate of value. To arrive at the capitalization rate, appraisers typically look at the market to assess the rates of return that investors require on similar properties, considering factors such as location, property type, and market conditions. This rate is then applied to the net operating income (NOI) of the property to calculate its value. The formula used is Value = NOI / Capitalization Rate.

In contrast, the cost approach focuses on the cost to replace or reproduce the property, while the sales comparison approach evaluates the value based on the sale prices of comparable properties. The price approach is not a standard appraisal method and does not pertain specifically to the capitalization of income. This distinction clarifies why the income approach is the correct answer when discussing the utilization of a capitalization rate in property valuation.