An external influence reduces a property's net income by $400 every month. The annual capitalization rate for the loss is 8%. What is the indicated loss to the whole property, before allocation between site and improvements?
Correct Answer
D) $60,000
400×12÷0.08 = 60000. Common errors: capitalizing the monthly loss without annualizing it gives $5,000; annualizing the loss but not capitalizing it gives $4,800; multiplying the annual loss by the rate instead of dividing gives $384.
Why This Is the Correct Answer
Option D is correct because the annual loss is $400 x 12 = $4,800, and $4,800 / 0.08 = $60,000. Capitalizing an annual loss with an annual rate keeps the basis consistent.
Why the Other Options Are Wrong
Option A: $384
Option A, $384, comes from $400 x 12 x 0.08, multiplying the annual loss by the rate instead of dividing. Capitalization divides: $4,800 / 0.08 = $60,000.
Option B: $4,800
Option B, $4,800, is $400 x 12, the annual loss before capitalization. Dividing by the 8% rate gives $60,000.
Option C: $5,000
Option C, $5,000, is $400 / 0.08, capitalizing the monthly loss with an annual rate without annualizing it. The annual loss of $4,800 divided by 0.08 gives $60,000.
Annualize, then divide
Turn monthly loss into yearly loss first, then divide by the annual rate to get the value loss.
How to use: Use this whenever a loss is given monthly and the rate is annual.
Exam Tip
Match the time period of the income to the rate, and remember capitalization divides by the rate.
Common Mistakes to Avoid
- -Capitalizing a monthly figure with an annual rate
- -Multiplying by the rate instead of dividing
- -Stopping at the annual income loss
Concept Deep Dive
Analysis
This question tests capitalization of an income loss, where the timing basis must match. A monthly loss is annualized first, then divided by an annual capitalization rate to give the value loss.
Background Knowledge
The capitalization of rental or income loss technique converts a supported loss in income into a loss in value by dividing by a capitalization rate. The income and the rate must be on the same basis, such as annual net income and an annual rate.
Real-World Application
An appraiser finds that nearby highway noise reduces net rent for a property by a supported monthly amount. Annualizing that loss and dividing by a market-derived rate gives the external obsolescence for the whole property.
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Previous Question
Building cost new $540,000 has total building depreciation $72,000. Separate site improvements cost new $35,000 have their own total loss $5,000. Add supported land $190,000 excluding sitework, and do not double count any component. What total results?
Next Question
Cost new of the improvements consists of hard costs of $360,000, soft costs of $40,000, and entrepreneurial incentive of $40,000, with no overlap among them. Total depreciation is estimated at 25% of this full cost, and the site is valued at $160,000. What value does the cost approach indicate?