An appraiser extracts overall capitalization rates (Ro) from four recent sales of retail strip centers. All properties are leased at or near market rent, have stable occupancy, and are subject to similar property tax and insurance conditions. One sale yields Ro = 5.9%, another Ro = 6.3%, a third Ro = 6.7%, and the fourth Ro = 7.1%. The appraiser determines the subject property faces greater long-term tenant turnover risk due to its reliance on short-term leases and less diversified tenant base. Assuming no other material differences, what is the most defensible Ro to apply to the subject, based on direct capitalization theory and market evidence?
Correct Answer
D) 7.1%
Direct capitalization theory holds that higher risk warrants a higher capitalization rate (i.e., lower value per dollar of income). Since the subject has greater tenant turnover risk than the comparables — which exhibit Ro ranging from 5.9% to 7.1% — the appraiser must select an Ro above the observed range or, more conservatively and defensibly, at the upper end of the range. Among the given options, 7.1% is the highest supported by market evidence and aligns with the principle that increased risk increases Ro. Selecting 5.9% (lowest) would understate risk; 6.3% or 6.7% would not adequately reflect the incremental risk identified. USPAP Standards Rule 1-5 requires such risk-based adjustments to be supportable and explained.
Why This Is the Correct Answer
Direct capitalization theory holds that higher risk warrants a higher capitalization rate (i.e., lower value per dollar of income). Since the subject has greater tenant turnover risk than the comparables — which exhibit Ro ranging from 5.9% to 7.1% — the appraiser must select an Ro above the observed range or, more conservatively and defensibly, at the upper end of the range. Among the given options, 7.1% is the highest supported by market evidence and aligns with the principle that increased risk increases Ro. Selecting 5.9% (lowest) would understate risk; 6.3% or 6.7% would not adequately reflect the incremental risk identified. USPAP Standards Rule 1-5 requires such risk-based adjustments to be supportable and explained.
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