Which type of income is used in the income capitalization approach?

In the income capitalization approach, net operating income (NOI) is the key metric used to evaluate the potential profitability of a property. NOI is calculated by deducting all operating expenses from the gross rental income generated by the property. This includes costs like property management fees, maintenance, property taxes, and insurance, but it excludes financing costs and capital expenditures.

Using NOI provides a clear picture of the income a property can produce from its operations, making it a reliable basis for valuation. Investors and appraisers focus on NOI because it reflects the income available before debt service and serves as an essential indicator of the property's financial health. This approach helps determine the value of the property by applying a capitalization rate to the NOI, allowing for an assessment of the investment's worth based on its expected income generation capabilities.

Gross rental income on its own does not account for expenses, appreciation income refers to increases in property value over time and is not directly related to income generation, and cash flow pertains to the income left after all expenses, which may include debt servicing and is not solely focused on operational performance. Therefore, net operating income stands as the correct basis for valuation in the income capitalization approach.