The Income Approach to Value for Commercial Property

How the Income Approach Works

1. Potential gross income. The rent the property would bring if it were fully leased at market rates, plus other income from the real estate, like parking or storage fees.
2. Vacancy and collection loss. No property is full all year, and not every tenant pays. Subtracting a vacancy and collection allowance gives effective gross income.
3. Operating expenses. Management, insurance, utilities, repairs and maintenance, and reserves for replacing major components. Mortgage payments and depreciation are not operating expenses. Property tax is handled separately, below.
4. Net operating income (NOI). Effective gross income minus operating expenses.
5. Capitalization. Value equals NOI divided by a capitalization rate (cap rate), the rate of return the market expects from this kind of property.

A Worked Example

Potential gross income (25,000 sq ft at $16 per sq ft)	$400,000
Less vacancy and collection loss (10%)	−$40,000
Effective gross income	$360,000
Less operating expenses (not including property tax)	−$100,000
Net operating income	$260,000
Cap rate (6% plus a 2% effective tax rate)	8%
Value ($260,000 ÷ 0.08)	$3,250,000

Now change one assumption. If the district’s model uses 5% vacancy for a building that actually runs at 10%, NOI rises to $280,000 and the value rises to $3,500,000. That one assumption adds $250,000 of value, about $5,000 a year in tax at a 2% rate.

The cap rate is just as sensitive. At 8.5% instead of 8%, the same $260,000 of NOI supports about $3,060,000, roughly $190,000 less.

How Property Tax Fits Into the Income Approach

A buyer counts property tax as an operating expense. In a tax appraisal, that creates a circle: the tax bill depends on the value being set. If the value is inflated, the tax bill on the operating statement is inflated too.

Appraisal districts handle this differently. Some treat property tax as an expense. Others leave it out and add the effective tax rate to the cap rate instead. This is called a loaded cap rate.

When a property is overvalued, we load the cap rate. That states the tax at the value the property should carry, not at the inflated value we’re protesting, and it keeps the expense line clean so the district can’t argue we padded it with a tax bill its own overvaluation created.

Two things follow. A loaded cap rate should only be compared to market cap rates after the tax rate is taken back out. And when the cap rate is loaded, property tax comes out of the expenses. Otherwise the tax gets counted twice.

To a buyer, the math runs the other way: a lower tax bill means higher NOI and a higher price.

Where the District’s Numbers Come From

Appraisal districts value thousands of commercial properties at once. They build income models with ranges for rent, vacancy, expenses, and cap rates by property type, class, and area, drawn from market publications, surveys, and the income history owners report.

Bexar Central Appraisal District’s 2026 Commercial Valuation Guidelines describe this directly, and they acknowledge that some properties’ actual income, expenses, and vacancy fall outside the ranges and need to be looked at individually. That’s the opening for an income-based protest. When the income approach doesn’t fit a property, the district falls back on sales comparison or cost.

Where Income Approach Values Go Wrong

Market rent the property can’t get. An older building, a weak location inside the submarket, or a layout tenants don’t want earns less than the range.

Stabilized vacancy on a property that isn’t stable. Lease-up, a lost tenant, or a dark anchor means real vacancy well above the model’s.

Expenses that are too low. Older buildings cost more to run. Insurance has risen sharply across Texas, and models often trail actual costs.

Reserves and leasing costs left out. Roofs, parking lots, and HVAC wear out. Tenant improvements and leasing commissions are a real cost of keeping a building leased.

The wrong class. A Class B building valued as Class A gets Class A rent and a Class A cap rate.

A cap rate that ignores risk. Short lease terms, a single tenant, or heavy rollover in the next two years all raise the return a buyer would require.

Income that isn’t from the real estate. Fees for services, equipment, or business operations in the NOI inflate the value of the building.

What We Need to Build an Income Approach

A rent roll as of January 1, operating statements for the last two or three years and the trailing 12 months, any recent appraisal, and notes on leasing activity, concessions, and major repairs. Your financial information stays confidential. We use it only where it strengthens your case.

Get the rent roll and operating statement template

This article is general information about Texas property tax, not legal advice. Rules and deadlines can change with each legislative session.