What defines a current equity dividend rate?
Correct Answer
A) Annual before-tax cash flow to equity divided by initial equity in this model.
The current equity dividend rate is period cash flow to equity divided by corresponding invested equity. It differs from an overall NOI/price rate and from total investment yield including reversion. A mortgage constant is a payment/principal ratio and is not necessarily the lender’s total yield.
Why This Is the Correct Answer
Option A is correct because the current equity dividend rate is annual before-tax cash flow to equity divided by the equity investment. Before-tax cash flow equals NOI minus annual debt service. This rate is also called the equity capitalization rate or cash-on-cash rate.
Why the Other Options Are Wrong
Option B: Annual property NOI divided by total property price.
Option B, annual property NOI divided by total property price, describes the overall capitalization rate. The equity dividend rate uses cash flow after debt service and divides by equity, not total price.
Option C: The total holding-period yield to equity, including all of the sale proceeds at resale.
Option C describes the total holding-period yield to equity including resale proceeds. That is an equity yield rate covering the whole holding period, not a single-period cash-on-cash measure.
Option D: The lender’s yield on its mortgage investment.
Option D describes the lender's yield on its mortgage investment. That concerns the debt position, not the return measured on the owner's equity.
Cash on cash
The equity dividend rate is the cash the investor receives this year divided by the cash the investor put in.
How to use: Use this to separate the equity dividend rate from overall and yield rates.
Exam Tip
Single-period plus equity points to the equity dividend rate; multi-period with resale points to an equity yield rate.
Common Mistakes to Avoid
- -Confusing the equity dividend rate with the overall rate
- -Including resale proceeds in a single-period equity rate
- -Dividing cash flow by total price instead of equity
Concept Deep Dive
Analysis
This question tests the definition of the equity dividend rate. It measures a single period's before-tax cash flow to equity against the equity invested. It is distinct from the overall rate, the equity yield rate and the lender's return.
Background Knowledge
In band-of-investment and mortgage-equity analysis, the property's income is split between debt and equity. The equity dividend rate relates the equity investor's annual cash flow after debt service to the equity invested.
Real-World Application
An investor buys a building with $400,000 of equity, and NOI minus debt service leaves $32,000 of annual cash flow. The investor's equity dividend rate is 8%, which the appraiser can compare with market rates in a mortgage-equity analysis.
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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