The subject property is a duplex with a failing roof. Tenants currently pay reduced rents, and annual NOI is $26,400. Once the roof is replaced, market rents apply and annual NOI will be $30,000. The replacement costs $25,000, can be done at once with no loss of rent, and is what buyers of similar duplexes would do. Sales of similar duplexes in good repair indicate a 7.5% overall rate. Which calculation indicates the as-is fee simple value?
Correct Answer
A) $30,000 capitalized at 7.5%, less the $25,000 roof
The 7.5% rate comes from duplexes in good repair, so it belongs with the $30,000 NOI of the repaired property: $400,000. Deducting the $25,000 cost to cure gives an as-is value of $375,000. Using the reduced $26,400 and also deducting the roof charges the same defect twice. Capitalizing $26,400 with no deduction applies a good-repair rate to temporary income, and capitalizing $30,000 with no deduction values the property as if already repaired.
Why This Is the Correct Answer
Option A is correct because the 7.5% rate fits the $30,000 NOI of the repaired duplex, indicating $400,000. A buyer would pay that less the cost to reach that condition, so $400,000 − $25,000 = $375,000 as is. The repair adds $48,000 of value for a $25,000 outlay, which is why buyers would make it.
Why the Other Options Are Wrong
Option B: $26,400 capitalized at 7.5%, less the $25,000 roof
Option B capitalizes $26,400 at 7.5% and then deducts the $25,000 roof: $352,000 − $25,000 = $327,000. The reduced rent exists because of the roof, so this charges one defect twice.
Option C: $26,400 capitalized at 7.5%, with no roof deduction
Option C capitalizes $26,400 at 7.5% with no roof deduction, giving $352,000. The 7.5% rate comes from sales in good repair, and the reduced rent is temporary, so this misses the $23,000 net gain a buyer can capture by making the repair.
Option D: $30,000 capitalized at 7.5%, with no roof deduction
Option D capitalizes $30,000 at 7.5% with no roof deduction, giving $400,000. That is the value as if repaired. As-is value has to reflect the $25,000 a buyer must spend, giving $375,000.
One defect, one charge
A failing roof can be charged through lost rent or through the repair bill, but not both. Pair the repaired income with the repair cost.
How to use: Use this when facts give both a discounted rent and a repair cost for the same problem.
Exam Tip
Check what condition the overall rate came from. If it came from properties in good repair, pair it with income in good repair and then deal with the cost.
Common Mistakes to Avoid
- -Deducting both the capitalized rent discount and the cost to cure
- -Reporting as-repaired value as as-is value
- -Applying a rate from sales in good repair to temporarily reduced income
Concept Deep Dive
Analysis
This tests matching income to condition and counting a defect once. The overall rate comes from sales in good repair, so it fits the repaired income of $30,000. The as-is value then deducts the cost of getting there. The rent discount and the roof cost are two views of the same defect, so a candidate who takes both overstates the loss.
Background Knowledge
Deferred maintenance is curable physical deterioration: items in need of repair as of the valuation date, measured by the cost to cure. The same defect may also appear as lost rent, but when the repair costs less than the capitalized rent loss, buyers make the repair and the cost to cure measures the loss. Charging both for one defect counts it twice.
Real-World Application
An appraiser values a rental property with a known roof problem and tenants on temporary rent concessions. The report capitalizes market income as if repaired and subtracts the contractor's bid, noting that the concessions end when the work is finished.
More Income Approach Questions
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