Calculating the income value of real estate

What is the income value?

The income value method is used to estimate the current value of rented properties and other investment properties. Unlike other valuation methods, the focus is not on the current condition of the property, but on the expected economic benefit for the buyer in the future. This is because the income value shows the return that a buyer can expect.

Calculating the income value – how it works

The simplified formula for the income value is:

Income value = net rental income per year / capitalization rate

To determine the net rental income, all non-apportionable costs as well as management and maintenance expenses are deducted from the gross rents. These include ancillary costs such as water, heating, and waste disposal.

The figure is then divided by a capitalization rate expressed as a percentage. This rate is individual for each property and reflects market expectations and the risk for the buyer. Numerous factors play a role in determining the capitalization rate, for example:

• The current risk-free interest rate

• Risk premiums for location, property type, and market environment

• Inflation and value change expectations

• Management and maintenance risks

Determining the capitalization rate is very complex, as it involves both market assumptions and property-specific assessments. Accordingly, it usually makes sense to seek the support of specialized experts such as real estate appraisers or brokers.

Example calculation of the income value

Assumption:

• Net rental income of an apartment building per year: CHF 150,000

• Capitalization rate: 5%

Minor changes in the capitalization rate have a major impact on the calculated value—the difference can quickly amount to several hundred thousand Swiss francs.

With a capitalization rate of 4.5 percent, the income value of the example property increases by more than 10 percent to 3,333,333 Swiss francs. And that is solely due to changed market expectations.

How accurate is an income approach valuation?

An income approach valuation does not provide the exact or “correct” sale price of the property being valued. Rather, it provides a plausible market value that serves as a reliable basis for the final price negotiations.

The accuracy of the appraisal depends heavily on the quality of the data, the assumptions made, and the current market situation.

A capitalization appraisal is particularly complex if the basic assumptions of stable income are not met. This is the case, for example, with very short leases or highly fluctuating market rents.

Uncertainties also arise from:

• long-term interest rate developments and economic prospects

• regional developments in rental prices

• possible vacancies

• unknown damage or investment requirements for the property

• a special standard of finish or when a unique property is being valued

What are the advantages and disadvantages of the income approach?

The income approach offers significant advantages over other valuation methods such as the comparative value method or hedonic models, particularly for investment properties.

Advantages:

• Close to market conditions, as it is based on realistically achievable rental income

• Particularly suitable for investment properties and investment objects

• Takes long-term management costs and sustainability into account

• Separation of land and building values enables differentiated analysis

Disadvantages:

• Highly dependent on assumptions about interest rates, costs, and vacancies

• Significantly more complex than other valuation methods

• Sensitive to market fluctuations

• Often less meaningful for owner-occupied single-family homes

Are specialists needed to calculate the capitalized value?

The actual formula for the capitalized value method seems simple. In practice, however, capitalized value estimation is challenging. This is not due to the calculation itself, but to the assessment of market assumptions, risks, and long-term developments.

In addition, the rents used to calculate the income value are not taken directly from the current situation, but are systematically standardized to a sustainable, market-standard yield. The valuation is not based on what is currently being paid, but on what is marketable in the long term.

Experienced brokers and real estate appraisers contribute crucial expertise, specialized tools, and detailed market knowledge. At the same time, they have the expertise to critically question results and adjust them based on factors such as financing costs, renovation needs, vacancy rates, or maintenance.

Support from experts is therefore often crucial for the quality and reliability of the valuation.

Sell successfully – with Engel & Völkers

A sound income valuation is an important step on the way to a successful real estate sale. In addition to the valuation, you benefit from market knowledge, specialized tools, and an international network of pre-registered prospective buyers.

Sell successfully now

We are happy to assist you in selling your property. Get in touch with us – we look forward to hearing from you.