An office building generates $500,000 in net operating income. The building cost new would be $4,000,000 with $800,000 in accrued depreciation. If the capitalization rate is 8%, what land value does the land residual technique indicate?
Correct Answer
B) $3,050,000
Why this is correct: The land residual technique isolates the land's contribution to value. Steps: 1) Building value = Cost new $4,000,000 - Depreciation $800,000 = $3,200,000. 2) Building income = Building value $3,200,000 × Cap rate 0.08 = $256,000. 3) Land income = Total NOI $500,000 - Building income $256,000 = $244,000. 4) Land value = Land income $244,000 ÷ Cap rate 0.08 = $3,050,000. Why the other choices are wrong: '$2,850,000' might miscalculate depreciation or income. '$6,250,000' could result from dividing NOI by cap rate without separating land and building. '$2,950,000' is a close but incorrect calculation. Exam tip: Land residual: allocate NOI between building and land based on their respective values and cap rates.
Why This Is the Correct Answer
Option C correctly applies the land residual technique step-by-step. First, the current building value is calculated as $4,000,000 - $800,000 = $3,200,000. Next, the income required to support this building investment is $3,200,000 × 8% = $256,000. The residual income attributable to the land is $500,000 - $256,000 = $244,000. Finally, capitalizing this land income at 8% gives $244,000 ÷ 0.08 = $3,050,000.
Why the Other Options Are Wrong
BUILD-LAND-CAP Method
BUILD (calculate current building value), LAND (find residual land income), CAP (capitalize land income). Remember: 'Buildings eat first, land gets leftovers' - the building takes its required income first, then remaining income goes to land.
How to use: When you see land residual problems, follow BUILD-LAND-CAP: 1) BUILD - find building value (cost new minus depreciation), 2) LAND - calculate building income needed (building value × cap rate), subtract from total NOI to get land income, 3) CAP - divide land income by cap rate for land value.
Exam Tip
Always work systematically through residual problems: identify what's known, what's unknown, calculate the known component's income requirement first, then find the residual income for the unknown component.
Common Mistakes to Avoid
- -Using the given land value instead of calculating it
- -Forgetting to subtract depreciation from building cost new
- -Capitalizing the total NOI instead of just the residual land income
Concept Deep Dive
Analysis
The land residual technique is one of the three residual techniques used in income capitalization approach when the value of one component (building) is known and you need to determine the value of the other component (land). This method assumes the building is at its highest and best use and calculates what income is attributable to the land after deducting the income required to support the building investment. The technique works by first determining the building's current value (cost new minus depreciation), then calculating the income needed to support that building value using the cap rate, and finally attributing the remaining income to the land. The land value is then determined by capitalizing this residual income at the same cap rate.
Background Knowledge
The land residual technique is used when the building value is known or can be estimated, and the appraiser needs to determine the land value by attributing residual income to the land after satisfying the building's income requirements. This technique assumes that the building represents the highest and best use of the land and that the same capitalization rate applies to both land and building components.
Real-World Application
Appraisers use land residual technique when valuing development sites where proposed improvements are known, or when the building is relatively new and cost data is reliable, helping determine if land prices are justified by the income-producing potential.
More Income Approach Questions
A residential subdivision has absorbed 120 units over the past 18 months. Based on this historical data, how long would it take to sell 80 remaining lots?
In neighborhood analysis, which factor would be considered an economic characteristic?
When delineating a market area for a single-family residence appraisal, which factor is MOST important?
In analyzing a special purpose property like a church, which approach to highest and best use is typically MOST appropriate?
In a balanced residential market, the typical months of supply would be:
In supply and demand analysis, which condition typically leads to increasing property values?
A retail property is currently operating as a restaurant but zoning allows for general commercial use. The restaurant generates $50,000 annual net income, while market analysis indicates retail use would generate $75,000. Renovation costs to convert would be $100,000. What is the highest and best use as improved?
A gas station on a corner lot in a gentrifying neighborhood continues to operate profitably but surrounding properties are being converted to upscale retail. This represents:
A property's highest and best use analysis shows that retail use would generate $50,000 annual net income, office use would generate $45,000, and residential use would generate $40,000. Using a 10% capitalization rate, what is the indicated value for retail use?
A comparable property sold 8 months ago for $450,000. Market analysis indicates property values have been appreciating at 6% annually. What is the time-adjusted sale price?
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