An appraiser is comparing a property's existing use with redevelopment, both lawful and feasible. Stabilized annual net operating income (NOI) is $100,000 as it exists and $250,000 if redeveloped, and the capitalization rate for each is 10%. Redevelopment would be immediate at a total cost of $2,000,000, with no delays or other costs. What is the higher net indicated value of the two alternatives?
Correct Answer
B) $1,000,000
Existing=100000÷0.10=1000000; redevelopment=250000÷0.10−2000000=500000; higher=1000000. Common errors: reporting the redevelopment value after costs, which is lower gives $500,000; not deducting the redevelopment costs gives $2,500,000; adding the existing-use value to the redevelopment value before costs gives $3,500,000.
Why This Is the Correct Answer
Option B is correct because the existing use is worth $100,000 ÷ 0.10 = $1,000,000, while redevelopment is worth $250,000 ÷ 0.10 − $2,000,000 = $500,000. The higher net indicated value is $1,000,000, so keeping the existing use produces more value. Redevelopment is not financially justified when its net value is lower.
Why the Other Options Are Wrong
Option A: $500,000
Option A, $500,000, is $250,000 ÷ 0.10 − $2,000,000, the redevelopment value after costs. It is the lower of the two figures, while the question asks for the higher, which is the $1,000,000 existing-use value.
Option C: $2,500,000
Option C, $2,500,000, is $250,000 ÷ 0.10 without deducting the $2,000,000 redevelopment cost. After costs redevelopment yields only $500,000, so the existing use at $1,000,000 is higher.
Option D: $3,500,000
Option D, $3,500,000, adds the $1,000,000 existing-use value to the $2,500,000 redevelopment value before costs. The two uses are alternatives, not additions, and the cost must be deducted; the higher net value is $1,000,000.
Net of costs decides
Compare existing value with redevelopment value minus costs; the bigger net number wins.
How to use: Use this whenever a question compares keeping a use against converting or redeveloping.
Exam Tip
Do not pick the largest gross figure; deduct conversion costs before comparing alternatives.
Common Mistakes to Avoid
- -Ignoring redevelopment costs
- -Choosing the higher NOI rather than the higher net value
- -Adding the values of two alternative uses together
Concept Deep Dive
Analysis
This question tests a highest and best use comparison between keeping the existing use and redeveloping. Capitalize each use's NOI, deduct redevelopment costs from the redeveloped value, and pick the higher net figure. The use producing the higher net value is the one that maximizes value.
Background Knowledge
Highest and best use requires a use to be legally permissible, physically possible, financially feasible and maximally productive. When comparing an existing use with redevelopment, the costs of conversion must be deducted from the redeveloped value. The use with the higher net value is the maximally productive one.
Real-World Application
An appraiser evaluating an older strip center considers redeveloping it as apartments. Although the apartments would produce higher NOI, the construction costs leave a net value below the center's existing value, so she concludes the current use remains the highest and best use.
More Income Approach Questions
Market analysis confirms that seller financing at 3%, versus a 6% market rate, increased a comparable sale price. What adjustment removes that financing premium?
At the same effective date, reliable value indications support $800,000 for continued use of a property as improved and $500,000 for its cleared site. Immediate demolition costs $100,000. These are the only feasible alternatives, with no other costs or timing differences. Which alternative has the higher net value?
Other relevant conditions equal, growth in the number of households with effective purchasing power in a market tends to have which effect?
In a lakefront market, paired sales show that direct water frontage has the largest price effect of any feature. Which approach to comparable selection best follows from this evidence?
Which circumstance can cause highest and best use as improved to differ from highest and best use as though vacant?
A small group of buyers in a market looks for specialized features that are uncommon in the broader housing supply. What term describes this group?
A neighborhood analysis should include all of the following EXCEPT:
A site legally permits at most 40 units and can physically support 50. Supported comparable analyses find 30 and 40 units financially feasible, with 40 units producing the highest net land value after costs, timing and required return. Which use is maximally productive among these alternatives?
Market evidence isolates a subject value loss from off-site landfill odors. Which listed cause is an external-obsolescence influence?
Which proposed use cannot pass the legal-permissibility screen without evidence that the necessary permission is reasonably probable?
People Also Study
Real Estate Market
13.6% of exam
Property Description
11.8% of exam
Land or Site Valuation
4.5% of exam
Sales Comparison Approach
16.4% of exam
Cost Approach
13.6% of exam
Previous Question
A market can support 40 additional comparable apartments over two years, while 80 units are expected to finish in that same period, with no offsetting removals. What does this suggest?
Next Question
Which proposed use cannot pass the legal-permissibility screen without evidence that the necessary permission is reasonably probable?