An appraiser is developing an overall rate for a 40-unit apartment building and has three indications. Five recent, verified sales of similar buildings show rates of 7.5% to 7.7%, centered on 7.6%. A band of investment using typical loan terms and one investor's stated equity dividend rate shows 7.3%. A debt coverage calculation using a lender's minimum ratio, the typical mortgage constant and loan-to-value ratio shows 5.5%. Which rate and reasoning are best?
Correct Answer
A) 7.6%, as recent verified sales show what buyers paid for similar income
Direct market evidence is the preferred source for capitalization rates, and five recent, verified sales in a tight range are strong evidence. The band rests on one investor's equity rate, so it serves as a check on the extracted rate. The debt coverage figure reflects a lender's minimum, which is a floor for underwriting and not what buyers paid. Averaging treats three unequal indications as equally valid.
Why This Is the Correct Answer
Option A is correct because direct market evidence is the preferred source for capitalization rates. Five recent, verified sales of similar buildings in a 7.5% to 7.7% range show what buyers actually paid in relation to income. The other two methods rest on thinner or narrower inputs in this assignment.
Why the Other Options Are Wrong
Option B: 7.3%, as the band reflects how typical purchases of this type are financed
Option B, 7.3%, relies on the band of investment. The band is a sound test of a rate, but here its equity input comes from one investor's statement, so it does not outweigh five verified sales.
Option C: 5.5%, as lender coverage requirements limit what typical buyers can pay
Option C, 5.5%, comes from a lender's minimum coverage ratio. That figure shows the income a lender requires to make the loan, not the rate buyers accept, and it sits well below every sale in the data.
Option D: 6.8%, as the average gives equal weight to each of the three methods
Option D, 6.8%, averages the three indications: (7.6% + 7.3% + 5.5%) ÷ 3. A simple average implies that all three have equal validity, and the low debt coverage figure pulls the result below every sale.
Sales speak, methods check
When good sales exist, they set the rate and other methods test it. The stronger the sales data, the less weight the built-up figures need.
How to use: Use this when several rate methods disagree and one rests on verified recent sales.
Exam Tip
Compare the data behind each rate, not just the method names. Count the sales, note whether they are verified, and spot inputs from a single source.
Common Mistakes to Avoid
- -Averaging rate indications of unequal quality
- -Treating a lender's underwriting minimum as a market rate
- -Giving a single investor's stated return the same weight as verified sales
Concept Deep Dive
Analysis
This tests judgment about the quality of rate evidence. All three methods are recognized, but they do not rest on equally strong data here. Five verified sales in a narrow range show actual buyer behavior, while the band depends on a single equity figure and the debt coverage result depends on a lender's minimum. Reconciliation weighs the evidence, so the strongest data controls.
Background Knowledge
An overall rate can be extracted from sales, built from a band of investment, or derived from a debt coverage formula. Direct market evidence is the preferred source when sufficient comparable sales exist, while the other methods are useful as checks. Each choice among alternatives in an appraisal is a form of reconciliation.
Real-World Application
An appraiser has good apartment sales but also receives a lender's underwriting figures showing a much lower rate. The report concludes on the extracted rate and describes the band and debt coverage results as secondary tests.
More Income Approach Questions
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