Extracting an overall rate from a comparable sale requires that the comparable's NOI be:
Correct Answer
C) Computed on the same basis as the subject's NOI
Use consistent NOI definitions, periods and reserve/tax conventions in extraction and subject application. Verify the cash-equivalent price and sale economics as well; financing concessions may affect price comparability even though debt service is not deducted from property NOI. Equal income magnitude or lender labeling is not required.
Why This Is the Correct Answer
Option C is correct because an overall rate extracted from a sale is only meaningful when applied to subject NOI computed on the same basis. Consistent definitions of income, expense items, reserves and periods let the extracted rate be applied without distortion.
Why the Other Options Are Wrong
Option A: Reported by the buyer's lender at closing
Option A requires the NOI to be reported by the buyer's lender at closing. The source of the data matters less than its accuracy and consistency; a lender's label is not a requirement for rate extraction.
Option B: Higher than the subject's net operating income
Option B requires the comparable's NOI to be higher than the subject's NOI. Rate extraction depends on consistent measurement, not on the comparable having larger income.
Option D: Adjusted for the buyer's financing terms
Option D calls for adjusting NOI for the buyer's financing terms. Financing affects the sale price, which may need a cash-equivalency adjustment, but debt service is not deducted from property NOI.
Same recipe for both NOIs
The comparable's NOI and the subject's NOI must be cooked from the same recipe: same items, same period, same reserve and tax treatment.
How to use: Use the same-recipe check whenever you extract a rate from a sale and apply it to a subject.
Exam Tip
Financing affects price (cash equivalency), not NOI; keep the two adjustments separate.
Common Mistakes to Avoid
- -Deducting debt service from NOI when extracting a rate
- -Mixing NOI with and without reserves between comparable and subject
- -Using the nominal sale price without checking cash equivalency
Concept Deep Dive
Analysis
This question tests the consistency requirement for extracting an overall capitalization rate from comparable sales. The rate is NOI divided by price, so the comparable's NOI must be defined the same way as the subject's, including period, reserves and tax treatment. Otherwise applying the extracted rate to the subject's NOI produces a distorted value.
Background Knowledge
An overall capitalization rate extracted from a sale equals the comparable's NOI divided by its cash-equivalent sale price. Rent and income should be estimated on the same basis for the subject and the comparables. Any financing concessions are addressed through the price, not by changing NOI.
Real-World Application
An appraiser extracting cap rates from three office sales notices that one buyer's reported NOI excluded replacement reserves while the subject's NOI includes them. The appraiser restates that comparable's NOI with reserves before computing its rate.
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 is valuing the fee simple interest in a triplex at market rents. A similar triplex sold for $450,000 cash with all units on leases that have four years remaining at rents well below market. Its NOI on those contract rents is $27,000, or 6.0% of the price; at market rents its NOI would be $36,000. Two other sales of similar triplexes leased at market rents indicate overall rates near 7.5%. How should the appraiser treat the 6.0% rate in valuing the subject?
Next Question
When reconciling historical and competitor vacancy evidence for an explicitly stabilized income model, what should primarily guide the selected vacancy rate?