Income Approach
What the exam tests
Income approach questions for residential properties focus on gross rent multipliers, direct capitalization, and operating expense analysis. The exam expects you to use market rent and market-derived rates.
Core rules
- Gross rent multiplier (GRM) = sale price / gross monthly rent; gross income multiplier (GIM) = sale price / annual gross income.
- Direct capitalization: value = net operating income / capitalization rate.
- Potential gross income minus vacancy and collection loss equals effective gross income; subtract operating expenses to get NOI. Debt service and income taxes are financing items, not operating expenses.
- Derive the cap rate from comparable sales or band of investment; do not borrow a rate without support.
- Use market rent, not below-market contract rent, for market value.
Worked example
A duplex has market rent of $1,800 per month per unit. Vacancy and collection loss is 5%. Operating expenses are $9,000 per year. A comparable duplex sold for $432,000 with annual gross income of $43,200, giving a GIM of 10.0. Subject potential gross income = $43,200; effective gross income = $41,040; NOI = $32,040. Applying the market GIM of 10.0 to gross income gives $432,000; direct capitalization at a supported 7.5% cap rate gives $427,200. Reconcile within the range.
Traps
Using contract rent when it is not market; deducting mortgage payments; omitting reserves for replacement; using a GRM on annual rent; applying a cap rate from a dissimilar property.