A DCF projection assumes rents grow 3% annually for ten years in a market where rents have been flat for five. The appraiser must:
Correct Answer
A) Support the growth assumption or revise it
Why this is correct: The Discounted Cash Flow (DCF) model's output is highly sensitive to the growth rate assumption. Professional standards require that all inputs be credible and supported by market evidence. Since the 3% annual rent growth projection contradicts the market's five-year history of flat rents, the appraiser must either provide compelling market data to justify the future growth or revise the assumption to align with the evidence. The original explanation correctly notes that an unsupported rate artificially manufactures value. Why the other choices are wrong: Adopting the assumption because clients expect growth violates the appraiser's duty to maintain independence and objectivity. Applying the same rate to expenses automatically is incorrect because expense growth rates are analyzed separately and often differ from rent growth rates. Extending the projection period to twenty years compounds the problem by making the unsupported assumption over a longer timeframe, increasing potential error. Exam tip: In DCF questions, any assumption that conflicts with recent market history is a red flag requiring support or revision.
Why This Is the Correct Answer
Why this is correct: The Discounted Cash Flow (DCF) model's output is highly sensitive to the growth rate assumption. Professional standards require that all inputs be credible and supported by market evidence. Since the 3% annual rent growth projection contradicts the market's five-year history of flat rents, the appraiser must either provide compelling market data to justify the future growth or revise the assumption to align with the evidence. The original explanation correctly notes that an unsupported rate artificially manufactures value. Why the other choices are wrong: Adopting the assumption because clients expect growth violates the appraiser's duty to maintain independence and objectivity. Applying the same rate to expenses automatically is incorrect because expense growth rates are analyzed separately and often differ from rent growth rates. Extending the projection period to twenty years compounds the problem by making the unsupported assumption over a longer timeframe, increasing potential error. Exam tip: In DCF questions, any assumption that conflicts with recent market history is a red flag requiring support or revision.
More income-approach Questions
In a percentage lease, rent is commonly structured as:
Escalation clauses and expense stops in a lease matter to the income analysis because they:
In a DCF, what is the reversion?
Potential gross income differs from effective gross income in that PGI assumes:
The reversion in a discounted cash flow model represents:
Two identical buildings differ only in risk: one has a single tenant on a short lease, the other five tenants on staggered terms. How do their cap rates compare?
Contract rent on a leased office is $30 per sq ft; market rent is $26. The $4 difference is called:
Building A (new, credit tenant, 20-year lease) and Building B (older, month-to-month tenants) sell the same week. Their cap rates should differ how?
An appraiser is analyzing a 15-unit apartment building. Market research indicates a 6% vacancy rate is typical for similar properties, but this property's historical vacancy has averaged 4%. The subject has experienced a 1% collection loss (uncollectible rents) over the past two years. When estimating effective gross income for the subject, what vacancy and collection loss percentage should the appraiser apply?
An overall rate extracted from a sale whose NOI excluded reserves, applied to a subject NOI that includes them, will:
People Also Study
Valuation Principles & Procedures
25% of exam
Property Description & Analysis
20% of exam
Market Analysis & Highest/Best Use
15% of exam
Appraisal Math & Statistics
15% of exam
USPAP (Ethics & Standards)
15% of exam