In real-estate valuation, the income approach estimates a property's value by converting its expected income into a present value.
The method is most useful for income-producing assets such as apartment buildings, offices, hotels, and shopping centers. An appraiser typically forecasts net operating income and applies a capitalization rate, or uses discounted cash-flow analysis to model income over time.
For a simple direct-capitalization calculation, value is estimated by dividing net operating income by the capitalization rate. A property producing $100,000 in annual net operating income at a 5% capitalization rate would indicate a value of $2 million under that simplified model.
The cost approach instead considers the cost of replacing the improvements, while the sales comparison approach relies on prices paid for similar properties. Appraisers may use more than one approach when market evidence allows.