The subject property is a multi-tenant retail center with mid-term leases to regional tenants and NOI of $96,000. An appraiser extracts overall rates from three recent sales. Sale 1, at 7.5%, has long leases to national tenants. Sale 2, at 8%, has mid-term leases to regional tenants. Sale 3, at 9.3%, has short leases and frequent tenant turnover. What is the most reasonable value indication?
Correct Answer
C) $1,200,000
Less certain income is capitalized at a higher rate, so the rate should come from the sale whose income risk matches the subject. Sale 2 matches, and $96,000 ÷ 0.08 = $1,200,000. Sale 1's rate gives $1,280,000, which credits the subject with stronger leases than it has. Sale 3's rate gives $1,032,258, which charges it for weaker ones. The simple mean of 8.27% gives $1,161,290 and lets the dissimilar sales set the answer.
Why This Is the Correct Answer
Option C is correct because Sale 2's mid-term leases to regional tenants match the subject, so its 8% rate best reflects the certainty of the subject's income. Dividing $96,000 by 8% indicates $1,200,000.
Why the Other Options Are Wrong
Option A: $1,032,258
Option A, $1,032,258, is $96,000 ÷ 0.093 using Sale 3. That sale has short leases and frequent tenant turnover, so its rate overstates the subject's risk. The correct calculation is $96,000 ÷ 0.08 = $1,200,000.
Option B: $1,161,290
Option B, $1,161,290, uses the unrounded mean rate: (7.5% + 8% + 9.3%) ÷ 3 = 8.2667%, and $96,000 ÷ 0.082667 rounds to that figure. Averaging gives equal say to two sales with different risk from the subject and is pulled up by Sale 3. The correct calculation is $96,000 ÷ 0.08 = $1,200,000.
Option D: $1,280,000
Option D, $1,280,000, is $96,000 ÷ 0.075 using Sale 1. Its long leases to national tenants carry less risk than the subject's leases, so its rate understates the subject's risk. The correct calculation is $96,000 ÷ 0.08 = $1,200,000.
Riskier income, higher rate
More doubt about collecting the income means a higher rate and a lower value. Pick the sale whose doubt level matches the subject.
How to use: Use this when several extracted rates come with facts about leases or tenants.
Exam Tip
Avoid averaging rates when the sales are described as different from one another. Those descriptions are there to guide a selection.
Common Mistakes to Avoid
- -Averaging rates from sales with clearly different risk
- -Using the lowest rate because it gives the highest value
- -Ignoring lease term and tenant quality when selecting a rate
Concept Deep Dive
Analysis
A judgment step comes ahead of the division. Three rates are available, and the facts about leases and tenants show which sale has income risk like the subject's. The reasoning is to compare risk first, select the rate, and then capitalize.
Background Knowledge
The capitalization rate reflects, among other things, how certain the income is. Sales with different lease terms and tenant quality can properly show different rates. An appraiser reconciles a range by comparing each sale's characteristics to the subject, not by mechanical averaging.
Real-World Application
An appraiser values a retail center and finds sales ranging from a national-tenant property to a struggling strip center. The appraiser gives most weight to the sale with a similar lease profile and explains why the others bracket the subject.
More Income Approach Questions
Which model describes yield capitalization of property benefits?
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