An appraiser is verifying the sale of a furnished 16-unit apartment building recorded at $2,000,000. The price includes furniture worth $40,000. The seller carried a below-market loan, and the appraiser estimates that this financing added $85,000 to the price. NOI from the real property is $150,000. What overall rate should the appraiser extract from this sale?
Correct Answer
D) 8.00%
The real property's cash-equivalent price is $2,000,000 − $40,000 − $85,000 = $1,875,000, so the overall rate is $150,000 ÷ $1,875,000 = 8.00%. The 7.50% figure uses the recorded price with no adjustment. Removing only the furniture gives 7.65%, and removing only the financing premium gives 7.83%.
Why This Is the Correct Answer
Option D is correct because the $2,000,000 recorded price includes $40,000 of non-realty items and an $85,000 premium for favorable financing. Removing both gives a cash-equivalent real property price of $1,875,000. Dividing the $150,000 of real property NOI by that price gives 8.00%.
Why the Other Options Are Wrong
Option A: 7.50%
Option A, 7.50%, is $150,000 ÷ $2,000,000. It relies on the recorded price, which includes furniture and a financing premium that the NOI does not reflect. The adjusted price of $1,875,000 gives 8.00%.
Option B: 7.65%
Option B, 7.65%, is $150,000 ÷ $1,960,000. It removes the furniture but leaves the $85,000 financing premium in the price. Removing both gives 8.00%.
Option C: 7.83%
Option C, 7.83%, is $150,000 ÷ $1,915,000. It removes the financing premium but leaves the $40,000 of furniture in the price. Removing both gives 8.00%.
Clean the price, then divide
Ask what the buyer paid for the real estate alone, on cash terms. That cleaned price is the only denominator that matches real property income.
How to use: Use this whenever a sale includes personal property, seller financing or other non-market terms.
Exam Tip
Overstating the price understates the extracted rate. When several items are bundled into a price, expect each one to need its own adjustment.
Common Mistakes to Avoid
- -Using the recorded price without verification
- -Adjusting for personal property but not for favorable financing
- -Adding the adjustments to the price rather than subtracting them
Concept Deep Dive
Analysis
Here the income is clean but the price is not. The rate must relate real property income to the real property's cash-equivalent price, so both the furniture and the financing premium must come out. Keeping income and price on the same basis is the point being tested.
Background Knowledge
Market-derived overall rates relate income to sale prices adjusted for cash equivalency. Non-real property items included in a sale must be removed from the price, and prices reflecting non-market financing may need adjustment. An unadjusted price produces a rate that does not represent the real property alone.
Real-World Application
An appraiser verifying a sale learns from the buyer that furnishings were included and the seller carried a low-rate note. After removing both effects from the recorded price, the appraiser extracts a rate suitable for use on an unfurnished subject with market financing.
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?
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An appraiser finds a comparable that sold for a cash-equivalent price of $690,000 with annual gross rent of $60,000. The subject has annual gross rent of $64,000. The market indicates the same price-to-income ratio applies to the subject, with no other adjustments. What is the indicated value of the subject, to the nearest dollar?