An overall rate extracted from a sale whose NOI excluded reserves, applied to a subject NOI that includes them, will:
Correct Answer
B) Understate the subject's value
Why this is correct: If the comparable's NOI excluded reserves (a higher NOI), the extracted overall capitalization rate (OAR) is higher. Applying that higher rate to the subject's lower NOI (which includes reserves) yields a lower value: Value = NOI / OAR. Why the other choices are wrong: "Overstate the subject's value" would occur if the comparable's rate were lower. "Produce the correct value either way" is false; inconsistent NOI definitions distort value. "Have no effect on the conclusion" is incorrect; the rate and NOI must align. Exam tip: Ensure NOI definitions match between subject and comparables when extracting or applying rates.
Why This Is the Correct Answer
Why this is correct: If the comparable's NOI excluded reserves (a higher NOI), the extracted overall capitalization rate (OAR) is higher. Applying that higher rate to the subject's lower NOI (which includes reserves) yields a lower value: Value = NOI / OAR. Why the other choices are wrong: "Overstate the subject's value" would occur if the comparable's rate were lower. "Produce the correct value either way" is false; inconsistent NOI definitions distort value. "Have no effect on the conclusion" is incorrect; the rate and NOI must align. Exam tip: Ensure NOI definitions match between subject and comparables when extracting or applying rates.
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An appraiser develops a band of investment rates for a retail strip center by analyzing local debt and equity market data. She determines a mortgage constant of 7.2% on a 75% loan-to-value mortgage with a 25-year amortization, and estimates an equity dividend rate of 11.5% based on investor surveys and recent limited-partnership placements. Assuming no income tax considerations and using the band-of-investment method, what overall capitalization rate does this support for a 75% loan-to-value financing structure?