Illinois Real Estate Practice Exam

When calculating the value of a building, Ellie subtracts operating costs and vacancy rate from the potential market rent. What is Ellie applying to derive the value?

1. Income approach

2. Cost approach

3. Comparable approach

4. Entrepreneurial approach

The correct answer is: Income approach

Ellie is applying the income approach to derive the value of the building. This method focuses on the income-generating potential of a property, which is particularly relevant for income-producing real estate such as rental properties. By subtracting operating costs and vacancy rates from the potential market rent, Ellie is determining the net operating income (NOI) that the property can generate. The income approach essentially assesses the present value of future cash flows associated with the property, making it a vital method for investors interested in real estate from a financial perspective. This approach is commonly used when valuing commercial properties or multifamily residential buildings, where rental income plays a significant role in determining the property’s value. In contrast, the cost approach assesses the value based on the cost to replace or reproduce the property, the comparable approach looks at the sale prices of similar properties in the area, and the entrepreneurial approach focuses on the potential profit generated by the entrepreneurial effort in developing a property. None of these methods would involve directly calculating the income derived from the property in the same manner that the income approach does.