Nationwide Mortgage Licensing System (NMLS) Practice Exam

Investment properties are generally appraised using which method?

1. Cost approach

2. Sales comparison approach

3. Income capitalization approach

4. Replacement cost approach

The correct answer is: Income capitalization approach

The income capitalization approach is the preferred method for appraising investment properties because it focuses on the property's ability to generate income. This approach evaluates the potential revenue the property can produce, discounted back to its present value. It factors in the gross income from the property, operating expenses, and ultimately derives a value based on the net operating income (NOI). This approach is particularly relevant for investment properties, as investors are primarily concerned with the return on their investment rather than just the physical characteristics or replacement costs. In contrast, while other approaches such as the cost approach or sales comparison approach may provide valuable insights in certain contexts, they do not fully capture the income-generating potential that is crucial for investors looking at rental or investment properties. The cost approach focuses on the cost to replace the asset, which is less relevant for investors interested in cash flow. Similarly, the sales comparison approach, which relies on comparing recent sales of similar properties, falls short as it does not consider the specific income-producing capabilities of the property under appraisal. Thus, the income capitalization approach stands out as the most relevant and effective method for assessing the value of investment properties.