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?
Correct Answer
C) Lower for A — safer income commands a lower rate and higher multiple
Why this is correct: The governing concept is that capitalization rates reflect the risk associated with the income stream. Lower cap rates indicate lower risk and higher value per dollar of NOI. Building A, with a new building, credit tenant, and long-term lease, represents safer, more durable income, so it should command a lower cap rate (higher value) compared to Building B with older physical condition and month-to-month tenants, which carries higher rollover risk. Why the other choices are wrong: "A lower for B, rewarding its flexibility" is incorrect because month-to-month tenancy increases risk, typically requiring a higher cap rate, not lower. "Identical rates, since both buildings are the same property type" is incorrect because cap rates vary within a property type based on specific risk factors. "Higher for A, since new buildings cost more" is incorrect because higher construction cost does not directly dictate a higher cap rate; risk drives the rate. Exam tip: Cap rates are risk premiums; safer income streams are capitalized at lower rates.
Why This Is the Correct Answer
Why this is correct: The governing concept is that capitalization rates reflect the risk associated with the income stream. Lower cap rates indicate lower risk and higher value per dollar of NOI. Building A, with a new building, credit tenant, and long-term lease, represents safer, more durable income, so it should command a lower cap rate (higher value) compared to Building B with older physical condition and month-to-month tenants, which carries higher rollover risk. Why the other choices are wrong: "A lower for B, rewarding its flexibility" is incorrect because month-to-month tenancy increases risk, typically requiring a higher cap rate, not lower. "Identical rates, since both buildings are the same property type" is incorrect because cap rates vary within a property type based on specific risk factors. "Higher for A, since new buildings cost more" is incorrect because higher construction cost does not directly dictate a higher cap rate; risk drives the rate. Exam tip: Cap rates are risk premiums; safer income streams are capitalized at lower rates.
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:
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:
Replacement reserves cover which kind of expenditure?
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
Previous Question
A small commercial building has potential gross income of $120,000 annually. The appraiser analyzes three comparable properties, which have stabilized vacancy and collection losses of 8%, 9%, and 7.5%. The subject property's owner provides records showing a 5% vacancy rate over the past three years due to long-term tenants. What is the appropriate stabilized vacancy and collection loss rate to use in estimating effective gross income?
Next Question
The discount rate in a DCF differs from a capitalization rate in that it: