What is the relationship between the capitalization rate and property value in the income approach?

The correct answer highlights a fundamental principle in the income approach to property valuation. The capitalization rate, often referred to as the "cap rate," is used to estimate the value of an income-producing property based on the income it generates.

When the cap rate decreases, it indicates that investors are willing to accept a lower yield on their investment, often due to increased demand for the property or improved market conditions. This increased willingness to accept a lower return typically reflects confidence in the stability and income-generating potential of the property, leading to a higher property value. Essentially, if a property generates a set level of income, and the required return (cap rate) decreases, the value of the property must increase to support that income.

Conversely, if the cap rate increases, it suggests that investors require a higher return, indicating a perception of increased risk or reduced demand for the property. In this case, the value of the property would decline to align with the higher cap rate based on the same income level.

This relationship between capitalization rates and property value is crucial for real estate investors and appraisers to understand, as it directly impacts investment decisions and pricing strategies in the market.