When Is The Income Approach Used?

[Terrel L. Shields]

Few people would build anything over 4 units to live in. You get a residential rate for insurance if you build a 4plex and live in one unit. My first mentor built 4 plexes, lived in one that was oversized, and rented the others. Then she put them on the market and built another. She made pretty good money doing that it appears. Now those 4plexes are real market bow-wows. If you give the proper reversionary value (higher) for a 5 year holding period in that time frame (early 90s) they capitalized quite well. Three units would service the debt and you kept them at least a year and didn't have to pay capital gains, move into the next one. Few appraisers would have really gone into the process of examining the tax advantage and the reversion at a higher price to get a property feel for the real income these made.

 

[DMZwerg]

My question is, for which property types is the income approach almost always used for ?
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This distinction is very important to me because I think I have seen the sales comparison approach still primarily used even for 2-4 unit dwellings, but am not sure.

The answer to #1 has already been covered (aka, for any primarily income producing type of property), but I think our questions imply you are looking for answers for a few questions you have not yet asked, namely:
"How reliable is the income approach, and for what property types is it more reliable and why?"

The sales comparison approach is often the primary approach for 2-unit properties as it is often considered more reliable than even the income approach. When dealing with 2-unit properties one unit is often owner and/or family occupied and in such cases the rent charged may be discounted or non-existent on one or both units thus reducing the amount of data available and the reliability of that data. A second factor is as one unit may be owner-occupied the rent charged on the other unit may not be as high as typical rents in the area as the owner is primarily looking to reduce mortgage payments rather than purchase for income stream and again rents may vary due to this reducing reliability of the approach for duplexes. Another factor is that size and quality of units can vary greatly in the same market due, again, due to current or previous owner occupancy and whim, thus leading to a wider range of potential and probable rental values.

As the number of units increases owner-occupancy tends to drop and the probability of owner-investors looking for a income stream from renting to unrelated tenants and maintaining more consistent standards of unit quality tends to become more dominant as number of hits hits then exceeds 4-units. Beyond a certain point (often 4-units) the property often changes in classification from residential to commercial.

So, there are reasons a particular appraiser may rely on one approach more heavily than another in a particular market or neighborhood, particularly when dealing with smaller multi-unit properties. Sales comparison approach is the dominant approach for most single family residential properties, but income approach becomes another standard then tends to become the more dominant approach to value as number of units rises, and especially after 4-unts.

Hopefully that sums things up a bit and helps clarify things for the questioner, and I hope my fellow appraisers will pick my reply apart and clarify it further for him if they feel I was off or did not cover these aspects well enough.