A comparable and subject are otherwise economically identical. A rate is extracted using comparable NOI before deducting a positive reserve, then applied to subject NOI after deducting that same reserve. Relative to a fully matching-basis calculation, the result is:
Correct Answer
B) Lower, because the income and rate conventions are mismatched.
Holding other economics fixed, a rate extracted from before-reserve NOI is higher than the after-reserve rate for the same sale. Applying that higher rate to the subject's lower after-reserve NOI double-penalizes the reserve and gives a lower value than a matching-basis calculation. Extract and apply rates using the same NOI definition.
Why This Is the Correct Answer
Option B is correct because the mismatch both lowers the income (after reserve) and raises the rate (extracted before reserve). Dividing a smaller NOI by a larger rate gives a lower value than a matching-basis calculation.
Why the Other Options Are Wrong
Option A: Higher, because the after-reserve NOI is the smaller of the two.
Option A says the result is higher because after-reserve NOI is smaller. A smaller NOI combined with a higher rate pushes value down, not up.
Option C: Unchanged, because reserve definitions do not affect the result.
Option C says reserve definitions do not affect the result. Because the reserve is positive, it changes both the extracted rate and the subject NOI, so the result does change.
Option D: Correct, because an extracted rate transfers to the subject.
Option D says the result is correct because an extracted rate transfers to the subject. A rate transfers properly only when applied to income defined the same way it was extracted.
Extract and apply alike
The income definition used to extract a rate must be the same one used when applying it.
How to use: Use this check whenever you carry a cap rate from comparables to the subject.
Exam Tip
When a question mixes before-reserve and after-reserve figures, work out the direction: smaller income with a larger rate means lower value.
Common Mistakes to Avoid
- -Applying a before-reserve rate to after-reserve income
- -Assuming reserve treatment has no effect on value
- -Getting the direction of the error backward
Concept Deep Dive
Analysis
This question tests consistency between how a cap rate is extracted and how it is applied. A rate extracted from before-reserve NOI is higher than one extracted from after-reserve NOI on the same sale; applying that higher rate to the subject's lower after-reserve NOI counts the reserve twice and depresses value.
Background Knowledge
Cap rates extracted from sales are only meaningful for income measured on the same basis. If comparable NOI is measured before certain recurring expenses, the subject's income should be measured the same way when that rate is applied.
Real-World Application
An appraiser notices that the published comparable cap rates were calculated without reserves while the subject pro forma deducts them. She either removes the reserve from the subject NOI or re-extracts the rates after reserves so both sides match.
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Previous Question
An appraiser reconstructing an operating statement reports net operating income (NOI) after a roof-replacement allowance and before financing. Which item is excluded from the deductions used to reach NOI?
Next Question
The subject property is a 20-unit apartment building. Last year's actual NOI was $90,000. The appraiser projects next year's stabilized NOI at $96,000. The seller's pro forma shows NOI of $105,000 at full occupancy. Buyers of similar buildings priced their purchases on next year's stabilized NOI, and those sales indicate an overall rate of 8%. What is the indicated value?