A client owns a duplex and asks an appraiser about two costs. A new city rental license fee of $1,200 a year, paid by the owner and not passed on to tenants, is expected to continue indefinitely. A sewer line needs a one-time repair costing $8,000, with no further cost expected. Buyers of similar duplexes deduct the full cost of a needed repair from the price. The overall rate is 8%, and neither item changes the rents or the rate. Which item has the larger effect on indicated value, and how much larger is that effect?
Correct Answer
A) The annual fee, by $7,000
The recurring fee reduces NOI and is capitalized: $1,200 ÷ 0.08 = $15,000 of value. The repair is a single cost that buyers deduct once, so it lowers value $8,000, and the fee has the larger effect by $7,000. Comparing the raw dollars gives $6,800 in favor of the repair, and multiplying the fee by the rate gives $7,904. Reporting $15,000 ignores the repair's effect on value.
Why This Is the Correct Answer
Option A is correct because the fee recurs and reduces NOI, so its value effect is $1,200 ÷ 0.08 = $15,000. The repair is a single cost that buyers deduct once, which lowers value $8,000. The fee therefore lowers value more, by $15,000 − $8,000 = $7,000.
Why the Other Options Are Wrong
Option B: The sewer repair, by $6,800
Option B says the sewer repair lowers value more by $6,800, which is $8,000 − $1,200. That compares one year of the fee with the repair; because the fee continues, its value effect is $1,200 ÷ 0.08 = $15,000, which exceeds the repair by $7,000.
Option C: The sewer repair, by $7,904
Option C says the sewer repair lowers value more by $7,904, which is $8,000 − ($1,200 × 0.08). Capitalization divides income by the rate, so the fee's effect is $15,000, not $96, and the fee has the larger effect by $7,000.
Option D: The annual fee, by $15,000
Option D says the annual fee lowers value more by $15,000, which is the fee's capitalized effect with nothing compared against it. The repair also lowers value by $8,000, so the difference between the two items is $7,000.
Annual gets capitalized, one-time doesn't
Divide a recurring cost by the rate; deduct a one-time cost once.
How to use: Use this when deciding how a cost found during an appraisal affects value.
Exam Tip
First sort each cost as recurring or one-time, then measure each one's value effect. At an 8% rate, each recurring dollar has the value effect of $12.50.
Common Mistakes to Avoid
- -Comparing one year of a recurring cost with a one-time cost
- -Capitalizing a one-time repair as if it recurred
- -Multiplying by the capitalization rate instead of dividing
Concept Deep Dive
Analysis
This tests how recurring and non-recurring costs reach value differently. A cost that continues each year lowers NOI, so capitalization turns a small annual amount into a larger value effect. A one-time cost is not in stabilized income and is taken once, so its value effect here equals its cost.
Background Knowledge
Direct capitalization converts a single year's stabilized income into value, so anything that changes income each year is multiplied in effect by the reciprocal of the rate. Fixed expenses, such as a license fee that does not vary with occupancy, are part of that annual income calculation. A needed repair is typically measured by its cost to cure and handled once.
Real-World Application
An owner thinks that a large repair bill matters far more than a new annual fee. An appraiser shows that buyers would deduct the repair once, but the fee reduces income in each year they own the property. Capitalized, the small fee has the bigger effect on price.
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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?