A property can be converted immediately to a legally and physically feasible residential rental use. Once complete, the rental use would have a stabilized annual NOI of $180,000, and the market indicates an overall capitalization rate of 9%. All immediate conversion, environmental and incentive costs total $200,000, and there is no delay and no other deduction. What is the indicated value of the property in its current condition?
Correct Answer
B) $1,800,000
Stabilized completed-use value =180000/0.09=2000000; current indication =2000000−200000=1800000 dollars. Common errors: not deducting the conversion costs gives $2,000,000; adding the costs instead of deducting them gives $2,200,000; also deducting a year of lost NOI, although there is no delay, gives $1,620,000.
Why This Is the Correct Answer
Option B is correct because the stabilized completed-use value is $180,000 / 0.09 = $2,000,000, and deducting the $200,000 of conversion, environmental and incentive costs gives $2,000,000 - $200,000 = $1,800,000. Direct capitalization converts NOI to value with a supported capitalization rate. Because the property is not yet converted, the current-condition indication reflects those costs.
Why the Other Options Are Wrong
Option A: $1,620,000
Option A, $1,620,000, also deducts a year of lost NOI as if the conversion caused a delay: $2,000,000 − $200,000 − $180,000 = $1,620,000. There is no delay and no other deduction, so the indication is $2,000,000 − $200,000 = $1,800,000.
Option C: $2,000,000
Option C, $2,000,000, is $180,000 / 0.09 without deducting the conversion costs. That is the completed-use value, not the current-condition indication; deducting $200,000 gives $1,800,000.
Option D: $2,200,000
Option D, $2,200,000, comes from adding the costs instead of deducting them: $2,000,000 + $200,000. Costs needed to reach the completed use reduce current value, so the answer is $2,000,000 - $200,000 = $1,800,000.
Capitalize, then subtract once
Value as completed equals NOI divided by the cap rate; as-is value equals that figure minus the costs to get there, subtracted one time.
How to use: Use this for any as-is versus as-completed problem with a stated cost to cure or convert.
Exam Tip
Compute the completed value first, then check the direction of the cost deduction and that nothing else is deducted. Distractors often skip the deduction, add it or deduct an item the facts rule out.
Common Mistakes to Avoid
- -Reporting the as-completed value as the as-is value
- -Adding the conversion costs instead of subtracting them
- -Multiplying NOI by the cap rate instead of dividing
Concept Deep Dive
Analysis
This question tests an as-is valuation of a property needing conversion: capitalize stabilized NOI to get the completed-use value, then deduct the costs required to reach that use. No delay or other deductions apply, so only the $200,000 of costs is subtracted once.
Background Knowledge
Direct capitalization estimates value by dividing net operating income by an appropriate capitalization rate. When a property must be converted before reaching stabilized income, a current-condition indication deducts the costs of getting there from the completed-use value. A use must also be financially feasible given market supply and demand.
Real-World Application
An appraiser values a vacant building that can be converted to rental housing. After supporting stabilized NOI and a market cap rate, the appraiser deducts the supported conversion and remediation costs to estimate value in its current condition.
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