A developer proposes a mixed-use project with phased leasing and irregular cash flows: $0 NOI in Years 1–2 (leasing-up period), $420,000 in Year 3, $610,000 in Year 4, and $750,000 in Years 5–10. The reversion is $9.2 million at the end of Year 10. Which statement best explains why a single overall capitalization rate would be inappropriate for valuing this property?
Correct Answer
B) Because direct capitalization assumes level or smoothly changing income, which does not reflect the actual cash flow pattern.
Direct capitalization applies a single capitalization rate to stabilized, typically level or trended NOI — it presumes a perpetual or stable income stream. Here, the income is highly irregular (zero for two years, then non-linear growth), violating the underlying assumption of direct capitalization. Discounted cash flow is required to explicitly model timing and magnitude of each cash flow. USPAP Standards Rule 1-10 states that the appraiser must use appropriate methods for the assignment; Advisory Opinion 21 confirms DCF is necessary when income is not reasonably anticipated to stabilize quickly or uniformly. Option B correctly identifies the core conceptual limitation.
Why This Is the Correct Answer
Direct capitalization applies a single capitalization rate to stabilized, typically level or trended NOI — it presumes a perpetual or stable income stream. Here, the income is highly irregular (zero for two years, then non-linear growth), violating the underlying assumption of direct capitalization. Discounted cash flow is required to explicitly model timing and magnitude of each cash flow. USPAP Standards Rule 1-10 states that the appraiser must use appropriate methods for the assignment; Advisory Opinion 21 confirms DCF is necessary when income is not reasonably anticipated to stabilize quickly or uniformly. Option B correctly identifies the core conceptual limitation.
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