Income Approach: Simple Steps to Value a Property Using Rental Income

If you own a rental home or think about buying one, the biggest question is: what is it really worth? The income approach answers that by looking at the money the property can generate. It’s a straight‑forward method that ties value to cash flow, not just to square footage or location.

Why the Income Approach Matters

Unlike the sales‑comparison method, which relies on nearby sales, the income approach focuses on the building’s ability to earn rent. This makes it perfect for apartments, office spaces, or any rental that has a steady stream of income. Investors love it because it tells you how long it will take to get your money back and what return you can expect.

Step‑by‑Step: Calculating Value with the Income Approach

1. Estimate Net Operating Income (NOI). Start with the total rent you expect to collect in a year. Then subtract operating expenses—property taxes, insurance, maintenance, and management fees. Don’t include mortgage payments; those are financing costs, not operating costs.

2. Choose a Capitalization Rate (Cap Rate). The cap rate reflects the risk and market conditions for that type of property. A lower cap rate means a safer, high‑demand asset; a higher cap rate signals more risk. You can find local cap rates by looking at recent sales of similar rental properties or using market reports.

3. Apply the Formula. Value = NOI ÷ Cap Rate. For example, if your NOI is $30,000 and the market cap rate is 6% (0.06), the property’s value would be $30,000 ÷ 0.06 = $500,000.

4. Adjust for Vacancy and Future Growth. Most investors assume a vacancy rate—say 5% of potential rent is empty. Reduce the gross rent by that amount before calculating NOI. If you expect rent to rise 3% a year, you can factor that into a higher NOI for a more optimistic valuation.

5. Run the Numbers Multiple Times. Play with different cap rates and vacancy assumptions to see how sensitive the value is. This helps you spot a good deal and understand the risk.

The income approach also works for commercial spaces. Instead of rent, you’d use the lease income from tenants, and the same cap rate formula applies. The key is to get accurate, up‑to‑date operating expense numbers; small errors can swing the value a lot.

Remember, the income approach isn’t the only way to value a property—but it’s the go‑to tool when the asset’s cash flow drives the purchase decision. Combining it with a sales‑comparison check gives you a fuller picture and can protect you from overpaying.

Ready to try it yourself? Grab your rent roll, list all expenses, pick a local cap rate, and plug the numbers into the simple formula. You’ll quickly see whether the price you’re looking at makes sense or if you need to negotiate. The income approach puts the numbers in your hands, so you can make smarter investment choices.