Prep for National Exam-Income Approach
Capital Expendature
An outlay of funds designed to improve the income-producing capabilities of an asset or to extend its economic life.
Residual Capitalization Rate
An overall capitalization rate used to estimate the resale price of the property; usually based on the anticipated stabilized income for the year beyond the holding period; also called terminal capitalization rate.
Sean is appraising a duplex and has found two good comparables in the subject's immediate area. A duplex on Zoll Street sold for $225,000 and a 4-plex on Hobbin Avenue sold for $350,000. ||The Zoll Street units rent for $750 and $800 per month and the operating expenses are 15% of the rent roll.||Each of the four units on Hobbin Avenue rent for $600 and the operating expenses are 19% of the rent roll.||What would Sean most likely conclude is a reasonable capitalization rate and GIM in the subject's market?
Cap rate 7%, GRM 145
Tom is analyzing the equity portion of an investment property. He has already estimated the NOI at $335,000. The mortgage encumbering the property is described as follows: $450,000 initial balance, 6% fixed annual interest for 30 years. The loan factor is .00599551. What is the monthly payment? What is the annual debt service? What is the loan constant?
$2,697.98; $32,375.76; 7.19%
Property owner Harriet is concerned about her water heater. She wants to start saving up to replace the water heater, which has a useful life of 10 years. The estimated cost of the water heater will be $5,000. Assume the interest rate is 5% per annum. Using the sinking fund factor of .07950457, what is the estimated replacement reserve for the water heater?
$397.52
The operating expense ratio (OER) can be expressed as
1 - NIR (where NIR is the net income ratio)
Use the following information to answer the question. ||Gross Income $100,000|Vacancy -3,000|Effective Gross Income $97,000|Operating Expenses -30,000|Net Operating Income $67,000|Debt Service -20,000 |Pre Tax Cash Flow $47,000||An office building has the preceding income, a 10% cap rate, and the owners paid a down payment of $250,000. The operating expense ratio equals:|
30.93%.
You are reconstructing an apartment complex's income statement. You estimate that gross income is $500,000, vacancy and bad debt allowance are 6%, and operating expenses are $205,000. What is the operating expense ratio? (Round to the nearest whole number)
44%
The sale price of an apartment building is $5,000,000. Its potential gross income is $1,000,000, its vacancy loss is $50,000, and its operating expenses total $350,000. What is the effective gross income multiplier?
5.26
Harriet is trying to establish an economic life for her subject property. She has found a comparable sale that is quite similar to her subject, and is located in the same market. It sold for $500,000 one month ago, and the sale price is reflective of market value. The building is 20 years old, and Harriet assumes the actual age is reflective of the effective age. The cost new of the building is $569,500. Harriet contacted the listing agent of the comparable and discovered that, prior to the sale, the comparable's site had a ground lease with an NOI of $10,000 and a land cap rate of 10%. Given these data, what is the estimated economic life of the improvements of the comparable sale property?
67 years
Net Lease
A lease in which the landlord passes on all expenses to the tenant.
Occupancy
A physical presence within and control of a property.
Pro Forma
A projected income and expense statement for proposed development. See also reconstructed operating statement.
Rent Roll
A report that is prepared regularly, usually each month, and indicates the rent-paying status of each tenant.
Income Capitalization Approach
A set of procedures through which an appraiser derives a value indication for an income-producing property by converting its anticipated benefits (cash flows and reversion) into property value. This conversion can be accomplished in two ways. One year's income expectancy can be capitalized at a market-derived capitalization rate that reflects the specified income pattern, return on investment, and change in the value of the investment. Alternatively, the annual cash flows for the holding period and the reversion can be discounted at a specified yield rate.
Reconstructed Operating Statement
A statement prepared by an appraiser to reflect potential future performance of a property allowing consideration of the historical income and expenses of an investment property. In preparing reconstructed operating statements, appraisers may consult accountants' financial balance sheets, comparable properties, auditors' statements, or historical data provided by the ownership entity.
Annuity
A sum of money paid at regular intervals, often annually.
Under what circumstances would a tenant in a strip retail center pay the property owner's insurance bill?
He agreed to a triple net clause in his lease.
Teri is appraising a duplex and has found three good comparables in the subject's immediate area. A duplex on Brook Lane sold for $295,000, a duplex on Zoll Street sold for $225,000, and a 4-plex on Hobbin Ave sold for $345,000.||Each unit on Brook Lane rents for $1,000 per month and the expenses are 12% of annual gross rent. The total building area is 1,690 square feet.||The Zoll Street units rent for $775 and $800 per month and the operating expenses are 15% of the rent roll. The total building area is 1,870 square feet.||Each of the 4 units in the Hobbin Avenue property rents for $600 and the operating expenses are 21% of gross. The total building area is 2,640 square feet. ||Which comparables have the highest GIM and the lowest capitalization rate?
Highest GIM Brook, lowest cap rate Hobbin
Operating Income
Income derived from the operation of a business or real property; indicates a stage in the profit and loss account where all direct costs and income from the operation have been taken into account; as distinguished from net profit or cash flow.
When contract rent is below market rent, what value exists for the tenants?
Leasehold value
Which of the following items should be included in a reconstructed statement of net operating income?
Management charges
Royalty
Money paid to an owner of real property or mineral rights for the right to deplete natural resource (e.g., oil, gas, minerals, stone, builders' sand and gravel, timber); usually expressed as a portion of the revenue received for, or price per unit of, the resource extracted.
Pre-tax cash flow (PTCF) is
NOI minus debt service
The debt coverage ratio (DCR) is
NOI/debt service
What is the term for income from a property or business, after deducting operating expenses, but before deducting income taxes and financing expenses?
Net operating income
Sean is appraising a duplex and has found two good comparables in the subject's immediate area. A 1,870 square foot duplex on Zoll Street sold for $225,000, and a 2,640 square foot 4-plex on Hobbin Ave sold for $350,000. ||The units on Zoll Street rent for $750 and $800 per month and the operating expenses are 15% of the rent roll.||Each of the 4 units on the Hobbin Street property rents for $600 and the operating expenses are 19% of the rent roll.||Which comparable has the highest value per unit and highest value per square foot?
Per unit Zoll, per square foot Hobbin
What is the term for the total income from a property before any vacancy loss or expenses are deducted?
Potential gross income
In order to estimate effective gross income, an appraiser needs to know which of the following?
Potential gross income and vacancy and collection loss
Which of the following is a variable expense?
Property management fees
On a reconstructed operating statement, which of the following items is considered a fixed expense?
Property taxes
Market Vacancy
The overall vacancy rate that occurs as a result of the interaction of supply and demand of a particular property type in a particular region or market. Market vacancy can be equal to frictional vacancy if the market has no structural problems; it can be less than frictional vacancy in rent-controlled markets.
Occupancy Rate
The percentage of properties in a given area that are occupied.
Cash Flow
The periodic income attributable to the interests in real property.
What is the definition of 'capitalization' as it is used in appraising?
The process of converting net income into an estimate of value
Overall Yield Rate (Yo)
The rate of return on the total capital invested, including both debt and equity. Also called property yield rate. When applied to cash flows, it is called a discount rate.
Present Value
The value of a future payment or series of future payments discounted to the current date or to time period zero.
Discount Rate
The yield rate used to convert future payments or receipts into present value; usually considered to be a synonym for yield rate.
Why are income and expenses annualized for non-residential properties when using the income approach?
They allow a more accurate estimate of a stabalized income stream to be calculated.
Which of the following is considered an operating expense for an apartment complex?
Weekly pool maintenance
The process of converting income into value is called
capitalization
The loss of income due to non-payment of scheduled rent is called
collection loss
The Net Income Ratio is the ________________ of the Operating Expense Ratio.
complement
The amount of rent for a property indicated in the lease is the
contract rent
Which of the following is not an operating expense?
debt service
If the market rent exceeds contract rent the difference is called
deficit rent
If the contract rent exceeds market rent the difference is called
excess rent
The relationship between the capitalization rate and the value is
inverse
The owner's estate in a property that is encumbered by a lease is called the
leased fee estate
The tenant's estate held during the term of a lease is called the
leasehold estate
Which of the following is a variable expense?
maintenance cost
In a net lease, the lessee is normally not responsible for:
mortgage debt service.
You are trying to find an apartment complex's net operating income. All of the following operating expenses might be included in the reconstructed operating statement EXCEPT:
mortgage debt service.
When estimating the net operating income of a property, an appraiser considers all of the following expenses EXCEPT:
mortgage payments.
When an appraiser analyzes the market using the gross rent multiplier technique, the appraiser estimates value by:
multiplying monthly market rent by the gross rent multiplier.
The tenant pays all expenses in a:
net lease.
The Net Income Ratio (NIR) is the
net operating income divided by the effective gross income
The Operating Expense Ratio (OER) is the
operating expenses divided by the effective gross income
The repayment of the original investment over the economic life of the property is called
recapture
You are appraising an income-producing property and need to estimate its replacement allowance. You should be careful to avoid duplicating replacement items that you may also have included in:
repair and maintenance.
The gross rent multiplier (GRM) and gross income multiplier (GIM) usually differ in that
the GRM is monthly; the GIM is annual
The debt coverage ratio (DCR) measures
the adequacy of NOI to cover the debt service
The replacement reserve (also known as reserves for replacement) is
the amount that is set aside to replace certain short-lived items
The break-even ratio measures
the occupancy level at which the property can cover NOI and debt service
Useful life is
the period of time over which a structure can reasonably be expected to perform the function for which it was designe
Operating expenses include
variable expenses
When extracting GRMs from the market for use in the income approach, an appraiser should look for dwellings that ___________ in order to select comparables.
were rented at the time of sale
The annual rent of a store is $50,000. The estimated vacancy rate is 10%. The annual expenses are: real estate taxes of $14,500; insurance premium of $1,900; management fee of $2,500; maintenance cost: $6,750. The operating expense ratio is __________; and the net income ratio is _______________.
.57; .43
Use the following information to answer the question:||An apartment complex is the subject of an appraisal assignment. Recent sales of similar apartment buildings reveal the following:||Sale 1: 20 units, gross annual income of $72,000, gross building area of 19,000 square feet, sales price of $352,800.||Sale 2: 38 units, gross annual income of $125,400, gross building area of 38,000 square feet, sales price of $627,000.||Sale 3: 45 units, gross annual income of $170,000, gross building area of 46,125 square feet, sales price of $884,520.||Sale 4: 28 units, gross annual income of $97,440, gross building area of 25,200 square feet, sales price of $516,432.||What is the range of the gross income multipliers?|
0.4
Capitalization Rate
1. Any rate used to convert income into value. 2. A rate of return on a real estate investment property based on the expected income that the property will generate. Capitalization rate is used to estimate the investor's potential return on his or her investment. This is done by dividing the income the property will generate (after fixed costs and variable costs) by the total value of the property. If you want to get technical, it is basically the discount rate of a perpetuity.
Janet is appraising a 3-unit building. Her discussions reveal the following data: Unit 1 has experienced 3 months' vacancy over the last year. Unit 2 has had 1 month. And Unit 3 has had 2 months. Assuming the vacancy rate remains stable for the upcoming year, what is the forecasted vacancy rate?
16.7%
Operating Statement
A financial statement that reflects the gross revenues, expenses, and net operating profit or loss of an investment over a fixed period.
Net Net Net Lease (NNN)
A lease in which the tenant assumes all expenses (fixed and variable) of operating a property except that the landlord is responsible for structural maintenance, building reserves, and management. Sometimes referred to as a "triple-net" lease. Note: this term may have a different definition in some geographic areas and markets.
Reversion
A lump sum benefit that an investor receives or expects to receive upon the termination of an investment; also called reversionary benefit.
Direct Capitalization
A method used to convert an estimate of a single year's income expectancy into an indication of value in one direct step, either by dividing the net income estimate by an appropriate capitalization rate or by multiplying the income estimate by an appropriate factor. Direct capitalization employs capitalization rates and multipliers extracted or developed from market data. Only a single year's income is used. Yield and value changes are implied but not identified.
Income Property
A piece of property for which the highest and best use is the generation of income through rents or other sources.
Capital
Accumulated goods and money which is most often used to generate additional income.
Replacement Allowance
An allowance that provides for the periodic replacement of building components that wear out more rapidly than the building itself and must be replaced during the building's economic life; sometimes referred to as reserves or reserves for replacement.
Reserve
An appropriation from surplus funds that is allocated to deferred or anticipated contingencies. In business, a credit account created to accumulate funds to retire debt or cover losses that are payable or expected to accrue in the future.
Overall Capitalization Rate (Ro)
An income rate for a total real property interest that reflects the relationship between a single year's net operating income expectancy and the total property price or value (Ro = Io/Vo).
Investment Property
Any piece of property that is expected to generate a financial return. This may come as the result of periodic rents or through appreciation of the property value over time.
What is the first step when reconstructing an operating statement?
Determine the potential gross income
What is the definition of 'fixed expenses?'
Expenses that do not vary with the level of occupancy of the property
In which type of lease does the lessor pay the property taxes, property insurance, and maintenance expenses?
Gross lease
When an appraiser is estimating net operating income, which of the following expenses should not be deducted from gross income?
Income tax expense
Compound Interest
Interest paid on the principal amount, as well as any accumulated interest.
Which of the following is true of a fixed expense?
It is not affected by income or other expense factors
Which of the following is not included in operating expenses?
Loan payments
Roy is appraising a duplex and has found three good comparables in the subject's immediate area. A duplex on Merry Lane sold for $295,000, a duplex on Napa Street sold for $225,000, and a 4-plex on Durango Ave sold for $345,000. Merry Laneâ€"Each unit rents for $1,000 per month and the expenses are 12% of annual gross rent. The total building area is 1,690 square feet. Napa Streetâ€"The units rent for $775 and $800 per month and the operating expenses are 15% of the rent roll. The total building area is 1,870 square feet. Durango Avenueâ€"Each of the 4 units rents for $600 and the operating expenses are 21% of gross. The total building area is 2,640 square feet. Which comparable has both the highest dollar per square foot and the highest GRM?
Merry
Fixed Expense
Operating expenses that generally do not vary with occupancy and that prudent management will pay whether the properties occupied or vacant.
Which of the following is calculated using the band-of-investment technique?
Overall capitalization rate
Going-In Capitalization Rate
Overall capitalization rate obtained by dividing a property's net operating income for the first year after purchase by the sale price of the property.
Vacancy and collection loss allowance is usually estimated as a percentage of what?
Potential gross income
Which of the following would be included in a reserve for replacements?
Roof replacement when it is worn out
Safe Rate
The minimum rate of return on invested capital. Theoretically, the difference between the total rate of return and the safe rate is considered a premium to compensate the investor for risk, the burden of management, and the illiquidity of the capital invested; also called riskless rate or relatively riskless rate.
Market Rent
The most probable rent the property should bring in a competitive and open market reflecting all conditions and restrictions of the lease agreement, including permitted uses, use restrictions, expense obligations, term, concessions, renewal and purchase options, and tenant improvements (TIs).
Natural Vacancy Rate
The percentage of vacant properties in a given area that is the result of natural turnover and market forces.
Anticipation
The perception that value is created by the exception of benefits to be derived in the future.
Operating Expenses
The periodic expenditures necessary to maintain the real property and continue production of the effective gross income, assuming prudent and competent management.
Discounted Cash Flow (DCF) Analysis
The procedure in which the discount rate is applied to a set of projected income streams and a reversion. The analyst specifies the quantity, variability, timing, and duration of the income streams and the quantity and timing of the reversion, and discounts each to its present value at a specified yield rate.
Income Approach
The process of estimating the value of property by considering the present value of a stream of income generated by the property.
Residual
The quantity left over; in appraising, a term used to describe the result of an appraisal procedure in which known components of value are accounted for, thus solving for the quantity that is left over, such as land residual or building residual.
Debt Equity Ratio
The ratio of the amount a mortgagor still owes on a property to the amount of equity they have in the home. Equity is calculated at the fair-market value of the home, less any outstanding mortgage debt.
Operating Expense Ratio (OER)
The ratio of total operating expenses to effective gross income (TOE/EGI); the complement of the net income ratio; i.e., OER = 1 - NIR.
Net Leasable Area
The space in a development, outside of the common areas, that can be rented to tenants.
The OER for most 300 unit apartment buildings in the subject market is .45. The subject's OER is .65. What could this be characteristic of?
The subject's operating expenses are high compared to competitive properties in the subject market.
Potential Gross Income (PGI)
The total income attributable to real property at full occupancy before vacancy and operating expenses are deducted.
What is the best explanation for why an appraiser conducts a rent survey?
To establish the subject property's market rent
What is the difference between potential gross income and effective gross income?
Vacancy and collection loss
What kind of capitalization calculates the annual effects of changing income and expenses to derive an opinion of present value?
Yield capitalization
What the subject property could rent for if it were vacant and available to be rented is called
market rent
Variable expenses change based upon
occupancy levels of the property
The formula to calculate the operating expense ratio for a property is:
operating expenses divided by effective gross income.
The management fee in a reconstructed operating statement is usually computed as a:
percentage of effective gross income.
The capitalization rate (Ro) is the
rate of return of and on investment
Which of the following is most likely a fixed expense?
real estate tax bill
The relationship between the net income multiplier (NIM) and the capitalization rate (Ro) is
reciprocal
Vacancy
The current percentage of vacant properties in a given area, regardless of why they are vacant.
The subject property is a brick split-level with 7 rooms, 3 bedrooms, and 2.0 baths. The subject is an "Ash" model. The GLA is 1,750 sf. The subject is listed for $200,000 and has been on the market for 132 days in a market where marketing times typically run 86 days. Appraiser Samantha is appraising the subject because the owner is concerned the list price might be too high. Samantha discovers an Ash that has recently sold for $210,000 two weeks ago. (Sale Z) However, it has 3 bathrooms. In all other ways the sale is similar to the subject property. Samantha wants to find out what a third bathroom is worth. In the same subdivision, Samantha has discovered two properties that are rented but were not sol Property A: 7 rooms, 3 bedrooms, 3.0 baths and 1,800 sf. This property is described as an "Evergreen" model. It is rented for $1,500/month. In the same subdivision Property B, another Evergreen model, is rented for $1,425 per month. It is the same as Property A, except that it has only two baths. The GRM in this market is 200. Given the above data, what adjustment should be made to Sale Z for bathroom count?
$15,000
Tom is appraising a 4-unit apartment building. The 4 units are rented for $1,300 each. The vacancy rate is 5%. The operating expense ratio is 45%. The debt service is $15,500. What is the pre-tax cash flow? (Round to the nearest hundre)
$17,100
Property owner Bob is concerned about his roof cover. He wants to start saving to replace the roof cover, which has a useful life of 20 years. The estimated cost of the roof cover will be $40,000. Using a straight-line method, what is the estimated replacement reserve for the roof?
$2,000
Tom is appraising a mixed-use property in Bloomingbrooke, a planned unit development (PUD). The owner is trying to establish a list price for her property. The PGI is $450,000. The market-derived vacancy rate is 20%. Operating expenses are $174,000, and pre-tax cash flow is $50,000. Tom's market research indicates four potential comparable sales. Sales 1, 2, and 3 are very similar, but Sale 4 is non-arm's-length. Sale 1: NOI of $160,000 and a sales price of $1,800,000; Sale 2: NOI of $180,000 and a sales price of $2,000,000; Sale 3: NOI of $165,000 and a sales price of $1,830,000. Sale 4 was a sale between relatives: NOI of $160,000 and a sales price of $1,000,000. After estimating the market capitalization rate, Tom's estimate of value for the subject property is (rounded to the nearest thousand)
$2,067,000
Pet Paradise pet store leases space in Northcoast Mall. Under its lease, Pet Paradise must pay a base rent of $2,000 per month. If sales revenue exceeds $50,000 per month, Pet Paradise must pay 5% of the extra sales. If Pet Paradise's total sales are $60,000 this month, how much total rent do they have to pay?
$2,500
How much net operating income is necessary to support a property value of $200,000 at a 12% capitalization rate?
$24,000
You are appraising a duplex and have found three good comparables in the subject's immediate area. A duplex on Brook Lane sold for $295,000, a duplex on Zoll Street sold for $225,000, and a 4-plex on Hobbin Ave sold for $345,000. The subject has an actual gross rent roll of $22,025 and an estimated market gross rent of $25,525. The projected NOI is $21,400. On the Brook Lane property, each unit rents for $1,000 per month, the expenses are 12% of annual gross rent, and the total building area is 1,690 square feet. For the Zoll Street property, the units rent for $775 and $800 per month, the operating expenses are 15% of the rent roll, and the total building area is 1,870 square feet. For the Hobbin Avenue property, each of the 4 units rents for $600, the operating expenses are 21% of gross, and the total building area is 2,640 square feet. What is the indicated value for the subject by the income capitalization approach?
$305,700
You are appraising a duplex and have found three good comparables in the subject's immediate area. A duplex on Brook Lane sold for $295,000, a duplex on Zoll Street sold for $225,000, and a 4-plex on Hobbin Ave sold for $345,000. The subject has an actual gross rent roll of $22,025 and an estimated market gross rent of $25,525. The projected NOI is $21,400. On the Brook Lane property, each unit rents for $1,000 per month, the expenses are 12% of annual gross rent, and the total building area is 1,690 square feet. On the Zoll Street property, the units rent for $775 and $800 per month, the operating expenses are 15% of the rent roll, and the total building area is 1,870 square feet. On the Hobbin Avenue property, each of the 4 units rents for $600, the operating expenses are 21% of gross, and the total building area is 2,640 square feet. What is the indicated value for the subject using a market-extracted gross income multiplier?
$306,300
The PGI of the strip shopping center that Mark is appraising is $1,315,000. The vacancy rate is 15%. The NIR is 35%. The mortgage has a beginning balance of $600,000 for 30 years, monthly payments, 5% fixed rate, and a mortgage factor of .00536822. What is the pre-tax cash flow (PTCF)(round to the nearest dollar)?
$352,561
The potential gross income (PGI) for a property is $500,000/year. The vacancy rate is 5%. The net income ratio is 40%. The effective gross income multiplier (EGIM) is 10. What is the indicated value?
$4,750,000
The owner of a rental house that abuts a busy road is concerned about his ad valorem assessment. The owner thinks the assessor has not taken the poor location of the house into consideration. The assessor has instructed the owner to have an appraisal performed that will analyze the external obsolescence on the property. Mary has agreed to appraise the property, and is told about the owner's concerns about the poor location. Mary knows that the possible negative impact of location on site value must be segregated from the negative impact on the building. The subject is rented for $1,500/month. A comparable property that is located in the same neighborhood, but is not adjacent to the busy road, is rented for $2,000/month. The land:building ratio is 1:4, and the monthly multiplier is 150. What is the external obsolescence attributable to the improvements?
$60,000
The effective gross income of a property is $125,000 and its operating expenses are 32% of the effective gross income. If the capitalization rate is 14%, what is the value of the property? (Round to the nearest whole number)
$607,143
Use your financial calculator or a compound interest table to answer the following question. Joe deposits $50,000 into an account that pays 8% per year, compounded annually. At the end of the fifth year, what is the total value of the account?
$73,466.40
Three comparable sales have the following data: A) sales price $100,000 and contract rent $1,250/month; B) sales price $104,000 and contract rent $1,300/month; and C) sales price $76,000 and contract rent $950/month. Given these three sales, if the subject property has a contract rent of $1,050/month, what is its indicated value?
$84,000
Net Operating Income (NOI)
The actual or anticipated net income that remains after all operating expenses are deducted from the effective gross income but before mortgage debt service and book depreciation are deducted. Note: this definition mirrors the convention used in corporate finance and business valuation for EBITDA (earnings before interest, taxes, depreciation, and amortization).
Frictional Vacancy
The amount of vacant space needed in a market for its orderly operation. In a stabilized market, where supply and demand are in balance, frictional vacancy allows for move-ins and move-outs. In markets for income-producing property, frictional vacancy measures the lost rental income as leases roll over and expire.
Risk Rate
The annual rate of return on capital that is commensurate with the risk assumed by the investor; the rate of interest or yield necessary to attract capital.
Internal Rate of Return
The annualized yield or rate of return on capital that is generated or capable of being generated within an investment or portfolio over a period of ownership. Alternatively, the indicated return on capital associated with the projected or pro forma income stream.
Effective Gross Income (EGI)
The anticipated income from all operations of the real property after an allowance is made for vacancy and collection losses and an addition is made for any other income.
What is the relationship between the level of risk and the capitalization rate?
The capitalization rate increases when the risk increases
