An appraiser uses the building residual technique on a property whose land value is known. How is the building value derived?
Correct Answer
B) Subtract allocated land income from NOI and capitalize the remaining building income.
Allocate land income as known land value multiplied by an appropriate land rate. Subtract it from total NOI to obtain building income, then divide by the building rate to estimate building value. Land value is not divided by its rate to obtain income, and accounting depreciation is not deducted from gross income.
Why This Is the Correct Answer
Option B is correct because the building residual technique deducts the income attributable to the land (land value × land rate) from NOI and capitalizes the residual building income at an appropriate building rate. Adding the known land value then gives total property value if needed.
Why the Other Options Are Wrong
Option A: Divide all of the NOI by the replacement cost new of the building.
Option A divides all of the NOI by the replacement cost new of the building. That produces a ratio of income to cost, not a building value, and it ignores the income attributable to land.
Option C: Multiply land value by the building rate instead of the land rate, and add it to NOI.
Option C multiplies land value by the building rate instead of the land rate and adds it to NOI. Land income is computed with the land rate and is subtracted from NOI, not added.
Option D: Subtract accounting depreciation from gross income and stop.
Option D subtracts accounting depreciation from gross income and stops. Accounting depreciation is a tax concept, not part of the residual technique, and the process does not capitalize any building income.
Known part takes its share
The known component (land) takes its income first; whatever is left over, the residual, belongs to the unknown component (building) and is capitalized.
How to use: Use this rule to set up any residual technique, physical or financial.
Exam Tip
Name the residual technique after the unknown component: building residual means the building's value is the one being solved.
Common Mistakes to Avoid
- -Using the building rate to calculate land income
- -Dividing land value by the land rate to get land income
- -Deducting accounting depreciation in an appraisal model
Concept Deep Dive
Analysis
This question tests the steps of the building residual technique. When land value is known, land income equals land value times the land rate; subtracting it from total NOI leaves building income, which is capitalized at the building rate. The wrong options misuse cost, rates or accounting depreciation.
Background Knowledge
Residual techniques split income between physical components (land and building) or financial components (mortgage and equity). In the building residual technique, land value is known, land income is land value times the land capitalization rate, and the remaining income is capitalized at the building rate. It assumes land value remains constant and land income is perpetual.
Real-World Application
An appraiser knows a site is worth $200,000 from vacant land sales and the property produces NOI higher than the land's share. The appraiser deducts land income at the land rate and capitalizes the remaining income at a building rate to estimate the improvements' contribution.
More Income Approach Questions
Which model describes yield capitalization of property benefits?
An appraiser is valuing a duplex. A market survey of recent duplex sales reports prices at 10.8 times potential gross income, with stabilized vacancy and credit loss of 10% of PGI and no other income. The subject's rent schedule is unavailable, but the property manager's records show collected income of $54,000 a year, in line with market rent and the 10% market loss. What value is indicated?
The subject property is a fourplex with annual EGI of $72,000 and operating expenses of $28,800. Of those expenses, $18,000 is fixed and $10,800 varies in direct proportion to EGI. The owner's annual mortgage payments are $21,000. An appraiser projects that EGI will fall 10% because of higher vacancy. What is the projected NOI?
Annual NOI available for debt service is $168,000 and total annual mortgage principal and interest debt service is $120,000. What is NOI ÷ debt service?
Annual PGI is $250,000 and combined vacancy and collection loss is explicitly 12% of that same PGI base. There is no other income. What annual EGI remains?
Annual PGI is $360,000 and combined vacancy and collection loss is explicitly 8% of that same PGI base. There is no other income. What annual EGI remains?
Annual PGI is $640,000. Combined vacancy and collection loss is 6.25% of PGI. There is no other income. What EGI remains?
An appraiser is updating a prior appraisal of a triplex with potential gross income of $60,000 and no other income. The prior appraisal used vacancy and credit loss of 5% of PGI, and a new survey of competing rentals indicates 8%. The operating expenses of $24,000 are property taxes, insurance and contract services that do not vary with occupancy, and the market overall rate remains 7.5%. By what percentages do effective gross income and indicated value decrease?
Annual potential rental income is $600,000 and vacancy loss alone is $36,000. What percentage of potential rent does that loss represent?
In the subject's market, lenders on fourplexes have lowered their typical loan-to-value ratio from 70% to 60%. The annual mortgage constant remains 5% and the equity dividend rate remains 10%. The subject's NOI has not changed. How does this affect the overall rate indicated by the band of investment and the indicated value?
People Also Study
Real Estate Market
13.6% of exam
Property Description
11.8% of exam
Land or Site Valuation
4.5% of exam
Sales Comparison Approach
16.4% of exam
Cost Approach
13.6% of exam
Previous Question
An appraiser finds a comparable that sold for a cash-equivalent price of $690,000 with annual gross rent of $60,000. The subject has annual gross rent of $64,000. The market indicates the same price-to-income ratio applies to the subject, with no other adjustments. What is the indicated value of the subject, to the nearest dollar?
Next Question
How does the explicitly defined EGIM income base differ from the overall-cap-rate base?