When using the income approach, what must an appraiser establish?

In the income approach to valuation, establishing the capitalization rate is crucial as it serves as a pivotal element in converting the net operating income (NOI) of a property into an estimate of value. The capitalization rate reflects the expected rate of return on an investment, incorporating the risk associated with the income potential of the property.

This approach specifically bases the valuation on the income the property generates, which is where the net operating income comes into play. However, while net operating income is necessary for calculations, the appraiser must also determine the appropriate capitalization rate to apply to that income. Without an accurately established capitalization rate, the valuation would lack context regarding the potential returns for an investor, making it impossible to derive a meaningful market value from the income generated.

Market value is ultimately the end goal of the income approach. However, establishing both the NOI and the capitalization rate must precede that process. Future income potential is a consideration that can influence how the capitalization rate is selected, but it does not directly relate to the appraiser's immediate requirement when using the income approach.

Thus, the capitalization rate is essential for the income approach, guiding the appraiser in assessing the value of the income-producing property accurately.