Which of the following is not a step in the income approach to value?

• A. Determine the replacement cost of improvements
• B. Calculate the net operating income
• C. Estimate total annual operating expenses
• D. Capitalize the net income into value

Answer: (B)

In the income approach to value, the focus is on the property’s ability to generate income and then converting that income into value. The process centers on estimating potential gross income, subtracting vacancy and credit losses to get effective gross income, deducting operating expenses to arrive at net operating income (NOI), and then capitalizing NOI to obtain value. So estimating total annual operating expenses is a step, and calculating the NOI is a step, and capitalizing that NOI into value is a step.

What doesn’t fit with the income approach is determining the replacement cost of improvements. Replacement cost is a concept used in the cost approach, where value is derived from the cost to replace improvements (minus depreciation). The income approach relies on income and expenses data rather than replacement costs.