Chapter 8 Valuation Using Income Approach

A small office building has the following characteristics: net operating income, $65,000; operating expenses and capital expenditures, $33,000; vacancy and collection losses, $5,000. What is potential gross income assuming an above-line treatment of capital expenditures?

$103,000

Which of the following should be accounted for in the calculation of net operating income?

Rental income Property maintenance Vacancies

Step-up Lease

Rental rates increase at predetermined rates at predetermined times

Appraisers generally forecast that a property's gross potential income will not be realized because

-not all tenants pay rent in a timely fashion -some tenants will vacate space after their lease term expires -Some existing leases may be at rental rates below market

If the appropriate cap rate for valuation is 5%, then the subject property should sell for .... times estimated NOI.

20

The cap rate abstracted from the market is 0.066. The subject's estimated net operating income is $60,000. What is the value of the property by direct capitalization?

909,091

Fee Simple Interest

An ownership interest in a property that is considered a complete interest without regard to any leases

Leased Fee Estate

An ownership interest in a property with existing leases

Which of the following are used in the direct capitalization approach to estimating a property's market value?

Capitalization rate Projected net operating income

Which of the following property features (1) affects the effective gross income multiplier of a comparable sale and (2) is included in the calculation of the EGIM?

Current vacancies

Present values are ______ future values.

GREATER THAN

When analyzing the operating expenses of a small office building, which of the following is a relatively fixed operating expense?

Hazard and fire insurance premium

When estimating the net operating income of a property, which of the following expenditures would be included?

Hazard and fire insurance premiums Property taxes

What is the relation between capitalization rates and estimated property values?

Inverse

Holding Period

Length of time an investment is held prior to sale or disposal.

Which of the following items might be included in the "reserve for replacement" line item in a reconstructed operating statement?

Lobby furniture in an office building Carpeting Apartment appliances

The rent that space in a property has the potential to generate in typical market conditions is called

Market Rent

Generally, which of the following is the most difficult to obtain and substantiate when abstracting a cap rate from a comparable sale?

Net operating income

The property being appraised currently has no vacancy. What would you likely conclude if the typical vacancy rate for comparable properties in the market is 10%?

Rents at the subject property are too low

Which of the following is most likely to be classified as a capital expenditure?

Roof replacement

Given the following information, calculate the net sale proceeds. Sale price: $974,000, Selling Expenses: $40,000; Remaining Mortgage Balance: $630,000; Net sale proceeds =

SALE PRICE - SELLING EXPENSES $934,000

Indicated Value

The final number produced by the direct capitalization approach

Discounting

The process of converting future values into present values.

Internal Rate of Return (IRR)

The rate of interest (discount) that equates the present value of the cash inflows to the present value of the cash outflows; that is, the rate of discount that makes the net present value equal to zero.

Net operating income (NOI)

The type of income to a property used in direct capitalization, calculated by deducting from potential gross income vacancy and collection losses and adding other income to obtain effective gross income. From this amount all operating expenses are subtracted, including management expense and a reserve for replacements, or capital expenditures, and other nonrecurring expenses.

Income Capitalization Approach

Used when valuing income producing property, value is determined by Net Operating Income (NOI.) Potential Gross Income - Vacancy and Collection Losses = Effective Gross Income Effective Gross Income - Operating Expenses = NOI

Appraiser are more likely to estimate actual capital expenditures in the period (year) they are expected to be incurred if the appraiser is using ____________ to estimate value.

a discounted cash flow model

The typical lease structure of ______ properties makes income multipliers a more appropriate valuation method than the lease structure of other property types.

apartment

In a "below-line" treatment of expected capital expenditures, capital expenditures

are subtracted from NOI to obtain the subject property's "net cash flow"

The income producing ability of properties generally

declines over time

higher purchase prices will _________ the capitalization rates.

increase

With direct capitalization, it is assumed that estimation of cash flows for an existing property beyond the next twelve months is performed by the

investors who purchased the comparable properties

When using discounted cash flow analysis, an appraiser will prepare a multi-year cash flow forecast, which is often referred to as a

multi-year pro forma

When using direct capitalization, ______ income is capitalized to obtain an estimate of value.

net operating

To obtain a cap rate from the sale of a comparable property, the appraiser must obtain the comparable property's

net operating income at time of sale sale price

Capitalization rates used to estimate the current market value of the subject property are sometimes referred to as the ______ cap rate.

overall going-in

Capitalization rates used to value the subject property are influenced by

returns available on alternative investments the risk of subject property expected appreciation rates of the property

Effective gross income for the subject property is calculated by

subtracting estimated vacancies and collection losses from potential gross income

A cap rate is most analogous to

the dividend yield on a stock

Final Estimate of Value

the final estimate determined by an appraiser when conducting an appraisal.

The longer the lease terms associated with the subject property or the comparable properties,

the less reliable is direct capitalization relative to discounted cash flow

When forecasting the income the subject property is expected to produce in the future, the appraiser's job is to estimate the income that

the typical investor would forecast

Federal income taxes are not considered operating expenses.

true

DCF analysis requires the appraiser to estimate

- the net cash generated by the sale of the property at the end of the expected holding period - the holding period expected by the typical market participant - future cash flows from annual operations

The accuracy of quantitative valuation techniques depends heavily on

-the experience of the appraiser -the quality of the cap rate or discount rate assumptions employed -the quality of the appraiser's cash flow assumptions

Cap rates

-vary inversely with expected appreciation in the value of the subject property -vary positively with expected returns on competing investment alternatives

In a market characterized by rising market rental rates, contract rental rates are generally "marked-to-market" (i.e., increased) by the owner when an existing lease expires. In general, leases are more frequently marked-to-market in

apartment properties

Potential gross income is defined as the total income the property would produce

assuming 100% occupancy and no collection losses

Cap rate information is often available from

brokerage firms data providers local research companies

Two apartment markets are considered to be equally risky. If market participants expect more price appreciation in market A than in market B,

cap rates will be lower in market A

The most common method used in DCF analysis to estimate the value of the subject property at the end of an expected 10-year holding period is to

capitalize NOI in year 11 into an estimated market value in year 10

As the cap rate increases, the price (value) to NOI ratio

decreases

Market value is determined by

demand and supply conditions

The use of a discounted cash flow valuation model requires the appraiser to

determine the expected holding period of the typical investor estimate NOI over the typical holding period

The main models or approaches to valuing real estate using income capitalization include

direct capitalization discounted cash flow

To abstract the cap rate from the sale of a comparable property, the appraiser

divides the NOI of the comparable property by the sale price of the comparable property

Other names for the cap rate used in direct capitalization include

going-in cap rate overall capitalization rate

The rental income an existing, stabilized property is expected to generate, after allowances for vacancies and collection losses, is called

effective gross income

Dividing the sale price of a comparable property by its annual effective gross income results in a(n) ______ which can be used to estimate the value of a subject property.

effective gross income multiplier

Potential gross income is equal to

effective gross income plus vacancy and collection losses

The projected amount of income that is "loss to lease" in a given year Multiple choice question.

equals what rental income would be if the property were fully leased at market rental rates, minus actual rental income

If it is correctly estimated, the effective gross income multiplier reflects

expected future vacancy expected rental growth current vacancy

Capital Expenditure (CapEx)

expenditures for replacements and alterations to a building (or improvement) that materially prolong its life and increase value.

Generally, when estimating market value, appraisers prefer to obtain the cap rate used to value the subject property

from comparable sale transactions

DCF valuation models

generally are better able to account for differences in lease terms and features than direct capitalization models

The income approach to valuation

is based on the concept of present value

income capitalization

is the process of converting a forecast of net operating income into an estimate of current market value

Direct capitalization does not require the appraiser to estimate NOI for the subject property beyond the next 12 months because

it is assumed the buyers and sellers of the comparable properties had already done so

The net sale proceeds (NSP) at the end of the assumed holding period is equal to the expected sale price

less selling expenses

Which of the following expenditures does not affect the calculation of net operating income?

monthly mortgage payments

Generally, the lower the capitalization rate used the

more certain the appraiser is of future net operating income

In the presence of miscellaneous income, effective gross income is equal to

potential gross income, plus miscellaneous income, minus vacancy and collection losses

Market rent can be defined as the property's

potential gross rent

Higher expected growth rates in rental income

produce higher effective gross income multipliers

Capital expenditures generally

prolong the economic life of the structure

When estimating the future NOI of an existing property, the appraiser usually considers

recent information from the subject property recent information from comparable properties