As we all know, the income capitalization approach is one of the three standard approaches for estimating the market value of an income producing property.  The other two approaches in this trilogy are the cost approach and the sales comparison approach.  Each of these approaches has its respective strengths and weaknesses in general.  Each will have respective strengths and weaknesses associated with a specific appraisal assignment.

But what is most interesting is that the primary and overwhelming objective of an appraisal assignment and subsequent report is to establish an estimate of market value for an income producing property.  The appraisal report is the analytical document that underpins virtually every credit decision about an income producing property.  Yet, most seasoned credit administrators will tell you that the primary source of repayment for an income producing property is the property’s cash flow.  Those credit administrators will also tell you that the lender looks to the guarantor to shore up debt service on the income producing property in times of cash flow crisis.  Finally, they will tell you that the property’s market value is relevant only in dire circumstance, i.e., when an asset sale or liquidation is the only remaining source of cash to service debt.

So why is it that the primary and overwhelming objective of an appraisal report is to establish the market value of an income producing property, when that market value is in the third rank of importance in providing cash to service debt on that income producing property?  Wouldn’t it make more sense, to the lender at least, to review a full and comprehensive analysis of present and prospective cash flow for the subject property, which then would lead to an estimate of market value using both the sales comparison and income capitalization approaches?

Your experience may differ from mine, but I find it quite frustrating to sift through the voluminous materials associated with an appraisal report to unearth actual data about existing cash flow for an income producing property.  I have an interest in the appraiser’s estimate of stabilized net operating income, but I also have an interest in existing net operating income and the significance and duration of any cash flow difference between what currently is and what might be.  What is – existing net operating income – may fall far short of satisfying proposed debt service on a loan amount linked to the market value of an asset based on hypothetical cash flow.  As a lender, that seems to be highly relevant information in making a credit decision.