Income Capitalisation Approach

We do a lot of rural valuations at Northern Property Valuers. At a recent inspection, I was asked about whether the farm will be valued based on how much it can be leased for? We refer to this as the Income Capitalisation Approach. This valuation method is not appropriate for rural properties and if applied is very inaccurate. There are large investment funds or similar groups that, when buying a farm, base their buy price on a capitalisation basis. They tend to pay amounts or make offers that are not in line with market parameters. Many groups have been burnt badly when it comes time to sell.

When valuing a property, we need to apply a similar methodology to how a likely buyer will. Most of the time, primary producers buy farms, while investors typically do not. 

We suggest the Income Capitalisation Approach is most appropriate for properties that will be viewed as investments. A block of flats, offices, retail and industrial properties are the market segments that attract investors. 

Investors are looking to make a return on their capital, therefore they will view the cashflow aspects of the property. Similar to a profit and loss. The landlord’s outgoings are deducted from the rental amount (Negotiations around the lease contract are needed to determine who will pay for what expenses, such as electricity, rates, insurance, etc). The sum is the Net Income. (Note though, that the Valuer may work with the Gross Income, as this is the only information available for the comparisons. Better to compare apples with apples type scenario). 

The comparisons, are the evidence used for establishing what is an appropriate rate of return. Different markets will attract different rates of return of the investment. Typically, the more risk, the higher return required. A property in poor condition will attract a higher return (as repairs and maintenance is more likely needed). A property in a remote location will require a higher return (these properties have less chance of getting a capital gain).

I hope this is of help and interest to some. A quick article from a question raised earlier today and thought I’d share some basic comments on the subject. 

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