A property is expected to have two lease-up years with no NOI, then materially changing positive cash flows and a terminal sale. Why is an explicit DCF useful?
Correct Answer
B) It models the differing amounts and timing of the forecast benefits.
An explicit forecast can represent lease-up, changes in income and terminal proceeds. Unadjusted capitalization of a nonrepresentative single year may miss those effects. This does not universally prohibit another supported technique, such as capitalization with justified stabilization adjustments.
Why This Is the Correct Answer
Option B is correct because a DCF forecasts each future period's income, including the reversion, and discounts those amounts to present value, so it reflects the differing amounts and timing of the benefits. Capitalizing one nonrepresentative year without adjustment may miss the lease-up period and later changes.
Why the Other Options Are Wrong
Option A: Mixed use creates an IRS requirement for separate appraisal methods.
Option A cites an IRS requirement for separate methods for mixed use. The stem does not describe a mixed-use property, and the usefulness of a DCF here comes from modeling uneven cash flows, not from any tax rule.
Option C: A terminal sale must exceed 20% of the total present value in a DCF
Option C claims a terminal sale must exceed 20% of total present value in a DCF. No such threshold defines a DCF; the reversion's share of value depends on the forecast and the rates used.
Option D: USPAP requires the discount rate to remain below the terminal cap rate.
Option D claims USPAP requires the discount rate to stay below the terminal cap rate. USPAP does not set rate relationships; rates are supported by market evidence, and that claim does not explain why a DCF fits this property.
Uneven income, use DCF
When income rises, falls or starts late, lay it out year by year and discount each amount.
How to use: Use this cue when a question describes lease-up, rollover or changing cash flows.
Exam Tip
Choices that cite specific regulatory requirements or percentage thresholds deserve scrutiny; confirm the rule exists before choosing them.
Common Mistakes to Avoid
- -Capitalizing a lease-up year's income as if it were stabilized
- -Believing professional standards fix the relationship between discount and terminal rates
- -Assuming a DCF is the only acceptable method for uneven income
Concept Deep Dive
Analysis
This question tests when yield capitalization (an explicit DCF) is especially useful. When income is uneven, with lease-up years producing no NOI followed by changing cash flows and a sale, a forecast that models each year's amount and timing captures effects a single-year capitalization can miss.
Background Knowledge
Yield capitalization converts future benefits into present value by forecasting each period's income and the reversion and discounting them at an appropriate rate. It is well suited to properties whose income is not stable, though direct capitalization with supported stabilization adjustments can also be appropriate.
Real-World Application
An appraiser values a newly built office building that will take two years to lease. She builds a DCF showing low income during lease-up, rising income as tenants move in, and a resale at the end, then discounts each year's cash flow.
More Income Approach Questions
Which model describes yield capitalization of property benefits?
An appraiser is valuing a duplex. A market survey of recent duplex sales reports prices at 10.8 times potential gross income, with stabilized vacancy and credit loss of 10% of PGI and no other income. The subject's rent schedule is unavailable, but the property manager's records show collected income of $54,000 a year, in line with market rent and the 10% market loss. What value is indicated?
The subject property is a fourplex with annual EGI of $72,000 and operating expenses of $28,800. Of those expenses, $18,000 is fixed and $10,800 varies in direct proportion to EGI. The owner's annual mortgage payments are $21,000. An appraiser projects that EGI will fall 10% because of higher vacancy. What is the projected NOI?
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The subject property is a neighborhood retail center. Its latest operating statement shows effective gross income of $150,000 and total expenses of $72,000, including $15,000 of uninsured storm cleanup that is finished and paid for and is not expected to recur. The other $57,000 is typical of competing centers. Sales of similar centers indicate an overall rate of 7.5% on stabilized income. What is the indicated value by direct capitalization?
Next Question
An appraiser is analyzing four sales of rental houses with monthly gross rent multipliers of 147, 190, 195 and 200. Verification reveals the 147 sale was a discounted transfer between family members; the others were open-market sales of similar houses. The subject’s market rent is $2,600 per month, and the appraiser concludes to the average of the sales that reflect market value. What is the indicated value?