A proposed building would cost $2,500,000 on a site costing $500,000, with immediate completion. Stabilized net operating income (NOI) of $180,000 is capitalized at 8%. There are no delays, other costs or other benefits. By how much do the building and site costs exceed the capitalized value?
Correct Answer
B) $750,000
2500000+500000−180000÷0.08 = 750000. Common errors: leaving out the site cost gives $250,000; reporting the capitalized value instead of the shortfall gives $2,250,000; subtracting the annual NOI instead of its capitalized value gives $2,820,000.
Why This Is the Correct Answer
Option B is correct because the capitalized indication is $180,000 ÷ 0.08 = $2,250,000. Total stated costs are $2,500,000 + $500,000 = $3,000,000. Costs exceed the indication by $3,000,000 − $2,250,000 = $750,000.
Why the Other Options Are Wrong
Option A: $250,000
Option A, $250,000, leaves out the $500,000 site cost: $2,500,000 − $2,250,000 = $250,000. Including the site gives $3,000,000 − $2,250,000 = $750,000.
Option C: $2,250,000
Option C, $2,250,000, is the capitalized value itself ($180,000 ÷ 0.08), not the amount by which costs exceed it. The shortfall is $3,000,000 − $2,250,000 = $750,000.
Option D: $2,820,000
Option D, $2,820,000, subtracts the annual NOI rather than its capitalized value: $3,000,000 − $180,000. Capitalizing first gives $3,000,000 − $2,250,000 = $750,000.
Capitalize before you compare
Turn income into value first (NOI ÷ rate), then compare value with total cost including land.
How to use: Use this whenever a question compares development cost with income-based value.
Exam Tip
Do not compare an annual income figure with a lump-sum cost. Convert the income to value at the stated rate first.
Common Mistakes to Avoid
- -Comparing annual NOI directly with total cost
- -Leaving land cost out of total development cost
- -Reporting the capitalized value instead of the difference
Concept Deep Dive
Analysis
This question tests a simple feasibility screen that compares total stated costs with the value indicated by capitalizing stabilized NOI. The NOI must be capitalized before comparison, and both building and site costs must be included. The shortfall is costs minus capitalized value.
Background Knowledge
A use must be financially feasible to be the highest and best use, meaning the value it produces should justify its cost. Direct capitalization converts a single year's NOI into value by dividing by an overall capitalization rate, which allows comparison with development cost.
Real-World Application
A developer asks whether a proposed building makes sense. The appraiser capitalizes the expected stabilized NOI and finds the resulting value falls well short of building plus land cost, signaling that the proposal may not be financially feasible as planned.
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Previous Question
Two proposed uses of a 10-acre vacant site are legally permissible, physically possible, financially feasible, and have comparable timing and risk. An apartment complex would have a completed value of $15 million and require $12 million of all non-land development costs; a retail center would have a completed value of $18 million and require $16 million of all non-land development costs. The land costs $2 million. Which use produces the higher surplus after land cost?
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Market evidence isolates a subject value loss from off-site landfill odors. Which listed cause is an external-obsolescence influence?