Real Estate Appraisal Practice Exam

Which valuation approach is typically based on the income generated by an investment property?

1. Cost approach

2. Sales comparison approach

3. Income approach

4. Market approach

The correct answer is: Income approach

The valuation approach that focuses on the income generated by an investment property is known as the income approach. This method is particularly relevant for properties that produce income, such as rental properties or commercial real estate. The income approach involves estimating the potential earnings of a property and determining its value based on the present worth of those future cash flows. The process typically includes factors such as rental income, operating expenses, and the capitalization rate, which reflects the expected rate of return for an investor. By analyzing these components, appraisers can establish a property's value based on its ability to generate income, making this approach a critical tool in investment property evaluation. Other approaches, like the cost approach, focus on the value of the land and the cost to construct the property, while the sales comparison approach looks at recent sales of comparable properties to determine value. The market approach similarly relies on sales data but is generally used for properties that do not generate income. Thus, the income approach is distinctly suited for evaluating the financial performance of income-producing properties.