A property has two lawful and feasible uses. Annual net operating income (NOI) attributable to the real estate is $180,000 in the current use and $220,000 in the alternative use. The capitalization rate for both uses is 10%. Converting to the alternative would happen immediately at a total cost of $300,000, with no delays or other costs. What is the net indicated value of the alternative use after conversion costs?
Correct Answer
C) $1,900,000
220000÷0.10−300000 = 1900000; current=180000÷0.10=1800000. Common errors: reporting the current-use value instead of the alternative gives $1,800,000; not deducting the conversion costs gives $2,200,000; capitalizing only the NOI increase gives $100,000.
Why This Is the Correct Answer
Option C is correct because the alternative use is worth $220,000 ÷ 0.10 = $2,200,000, and deducting the $300,000 conversion cost gives $1,900,000. That net value is what the alternative offers after paying to convert.
Why the Other Options Are Wrong
Option A: $100,000
Option A, $100,000, capitalizes only the NOI increase and then deducts the cost: ($220,000 − $180,000) ÷ 0.10 − $300,000. That measures the net gain over the current use, not the alternative's net value of $1,900,000.
Option B: $1,800,000
Option B, $1,800,000, is the current use value ($180,000 ÷ 0.10). The question asks for the alternative's net value, which is $2,200,000 − $300,000 = $1,900,000.
Option D: $2,200,000
Option D, $2,200,000, capitalizes the alternative's NOI ($220,000 ÷ 0.10) but does not deduct the $300,000 conversion cost. The net value is $1,900,000.
Capitalize, then pay to convert
Value the alternative as if converted, then subtract what it costs to get there.
How to use: Use this sequence when comparing an existing use with a conversion alternative.
Exam Tip
Read whether the question asks for the alternative's net value or the gain over the current use; they are different numbers.
Common Mistakes to Avoid
- -Ignoring conversion costs
- -Reporting the gain over the current use as the net value
- -Reporting the current use value when the alternative was asked for
Concept Deep Dive
Analysis
This question tests comparing uses under highest and best use analysis. Capitalize the alternative use's NOI and deduct the stated $300,000 conversion cost to find its net value; the current use value of $1,800,000 serves as a comparison.
Background Knowledge
In highest and best use analysis, a use must be legally permissible, physically possible and financially feasible, and the use producing the highest value is selected. Conversion costs must be deducted when comparing an alternative use with the current use.
Real-World Application
An appraiser considers converting an older office building to apartments, which would raise NOI from $180,000 to $220,000 at a $300,000 cost. The net value of $1,900,000 exceeds the current use value of $1,800,000, supporting the conversion.
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