Texas Crammer Practice Exam

Which approach to property valuation bases its estimate on the income the property generates?

1. Cost approach

2. Replacement cost approach

3. Income approach

4. Market approach

The correct answer is: Income approach

The income approach to property valuation is a method that assesses a property's value based on the income it generates, typically through rental income or cash flow. This approach is especially useful for investment properties where the primary goal is to evaluate the financial return on the investment. Assessors and investors use the income approach by analyzing the property's potential income and applying a capitalization rate, which reflects the investor's desired return and risk level. This method effectively connects the property's market value to its income-producing abilities, making it a preferred choice for valuing commercial real estate, multifamily properties, and other income-generating assets. Each of the other approaches to valuation focuses on different aspects. The cost approach evaluates the value based on the cost to replace or reproduce the property, considering depreciation. The replacement cost approach is a variant that specifically looks at the cost to replace the property with a similar one and does not directly take income into account. The market approach relies on comparing the property to similar properties that have recently sold in the market, thus focusing on sales data rather than income.