What is the income approach's key input variable known as?

The correct answer is the capitalization rate, which is a crucial input variable in the income approach to valuation. In this approach, the capitalization rate is used to convert expected future income into a present value. It essentially reflects the relationship between the income a property generates and its market value.

The capitalization rate is derived from the expected return on investment for similar properties in the market. It serves as a risk assessment tool, indicating the yield that investors require, given the perceived risks and uncertainties associated with the property’s income stream. For example, a higher capitalization rate suggests a higher level of risk associated with the investment, indicating that investors expect a higher return on their investment as compensation.

In practice, the capitalization rate aids in estimating the value of income-producing real estate by applying it to the net operating income of the property. By dividing the net operating income by the capitalization rate, one can derive the property's estimated market value. This approach is widely used in the valuation of commercial and investment properties, where generating income is a fundamental aspect of determining value.