The subject property is a 12-unit apartment building with stabilized annual NOI of $108,000. An appraiser applies a 7.5% overall rate from sales of similar buildings. Those sales, and others in the market, also closed at $138,000 to $150,000 per unit. What should the appraiser do with the direct capitalization result?
Correct Answer
C) Analyze the difference by rechecking the NOI, the rate and the unit comparability
The result is $108,000 ÷ 0.075 = $1,440,000, or $120,000 per unit, which falls below the $138,000 to $150,000 range. A wide variation between units of comparison calls for analysis: the NOI, the rate and differences such as unit size may each explain it. Raising the value or changing the rate to force agreement replaces analysis with a target, and accepting the result misreads the arithmetic.
Why This Is the Correct Answer
Option C is correct because $108,000 ÷ 0.075 = $1,440,000, or $120,000 per unit, which falls below the $138,000 to $150,000 range. A variation that wide should be analyzed. Rechecking the NOI, the rate and the comparability of the units identifies whether the income figure is wrong or the subject really differs from the sales.
Why the Other Options Are Wrong
Option A: Accept the result, because it falls within the per-unit range of the sales
Option A says the result falls within the per-unit range, but $1,440,000 ÷ 12 = $120,000 per unit, which is $18,000 below the $138,000 low end. Accepting it leaves an unexplained gap between two market measures.
Option B: Raise the result to $138,000 per unit, the low end of the range of the sales
Option B raises the result to $138,000 per unit, or $1,656,000. Moving to the edge of the range without finding the cause replaces the income analysis with a target number, and the subject may have real differences that justify a lower price per unit.
Option D: Lower the overall rate until the result falls within the range of the sales
Option D lowers the overall rate until the result falls within the range. Reaching even $138,000 per unit would take a rate near 6.5% ($108,000 ÷ $1,656,000), well below the 7.5% the sales show. Adjusting a market-derived rate to reach a desired value is not analysis.
Gap means look, not force
If a cross-check misses the range, treat the miss as a question. Find the cause before changing any number.
How to use: Use this whenever a capitalized value disagrees with price per unit or price per square foot.
Exam Tip
Convert the capitalized value to the unit in the facts before judging it. Be wary of answers that change an input just to reach a desired result.
Common Mistakes to Avoid
- -Skipping the per-unit conversion and assuming the result fits
- -Forcing the result to the edge of the range
- -Changing the overall rate to reach an expected value
Concept Deep Dive
Analysis
The candidate must convert a direct capitalization result into the unit buyers use for apartments and judge it against the market. At $120,000 per unit, the result sits well below the range, so something needs explaining. The sound response is to look for the cause, since the subject's income, the rate or the comparability of the units could each be responsible.
Background Knowledge
Units of comparison state a price in the terms buyers use, and apartments are typically compared by sale price per unit. Appraisers use all applicable units and analyze wide variations between results. A check of this kind can reveal an income estimate that is too low, a rate that does not fit, or real differences such as smaller units.
Real-World Application
An appraiser finds that a capitalized value for an apartment building works out well below recent prices per unit. Further review shows the subject has mostly studio units while the sales have two-bedroom units, and the report explains the difference.
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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Previous Question
The subject property is a triplex. Its operating statement shows PGI of $52,000, EGI of $48,000 and operating expenses of $19,200, including a $2,400 replacement reserve. The appraiser's survey of similar triplexes shows operating expense ratios of 33% to 37% of EGI, all reported with no replacement reserve in expenses. On the same basis as the survey, what is the subject's operating expense ratio, and how does it compare with the survey?
Next Question
An appraiser is developing an overall rate for a 12-unit apartment building by the band of investment, based on 75% debt at a 6.5% mortgage constant and 25% equity at an 11% equity dividend rate. Before the report is issued, tighter credit raises the mortgage constant by 0.50 percentage point and the equity dividend rate by 1.00 percentage point. The loan-to-value ratio does not change. By how much does the indicated overall rate rise?