What is the purpose of a simple mortgage-equity band using a mortgage constant and equity dividend rate?
Correct Answer
B) Develop an overall capitalization rate from compatible cash-flow components.
The simple mortgage-equity band combines annual mortgage constant and current equity dividend rate at their capital fractions. More elaborate mortgage-equity yield methods also exist; the terms are not universally synonyms for this simple weighted formula. It is a rate-development technique rather than a cost-depreciation calculation.
Why This Is the Correct Answer
Option B is correct because the band of investment combines the mortgage constant and the equity dividend rate, weighted by the loan and equity fractions, into an overall capitalization rate. Both rates relate annual cash flows to their capital components, so they are compatible.
Why the Other Options Are Wrong
Option A: Calculate physical depreciation in the cost approach.
Option A says the band calculates physical depreciation in the cost approach. Depreciation is estimated in the cost approach by other methods; the band of investment develops a capitalization rate in the income approach.
Option C: Select the highest and best use of the site without any feasibility analysis.
Option C claims the band selects the highest and best use of the site without any feasibility analysis. Highest and best use requires testing legal, physical, financial and productivity criteria; a rate formula does not select a use.
Option D: Set the comparable-sale adjustments by formula.
Option D says the band sets comparable-sale adjustments by formula. Sales comparison adjustments are supported by market evidence, not derived from a mortgage-equity rate calculation.
Debt slice plus equity slice
Overall rate equals the loan share times the mortgage constant plus the equity share times the equity dividend rate.
How to use: Use the two-slice formula to recognize and compute any band of investment question.
Exam Tip
If an answer mentions developing an overall rate from debt and equity components, it describes the band of investment.
Common Mistakes to Avoid
- -Confusing the mortgage constant with the interest rate
- -Weighting the rates by the wrong capital fractions
- -Treating the band as a cost-approach tool
Concept Deep Dive
Analysis
This question tests the purpose of the simple mortgage-equity band of investment. The technique weights the mortgage constant and the equity dividend rate by their shares of the purchase price to develop an overall capitalization rate. It is a rate-development tool, not a depreciation, highest and best use or adjustment method.
Background Knowledge
The band of investment derives an overall rate by weighting the capitalization rates of a property's financial components. In its simple form, the overall rate equals the loan ratio times the mortgage constant plus the equity ratio times the equity dividend rate. The return of investment is reflected in the mortgage constant's amortization and, implicitly, in the equity dividend rate.
Real-World Application
An appraiser learns that typical lenders offer 70% loans at a given mortgage constant and that investors seek a certain cash-on-cash equity return. Weighting the two rates by 70% and 30% gives a supported overall rate to cross-check rates extracted from sales.
More Income Approach Questions
Which stated cause of supported value loss is external?
Improvement cost new is $450,000. Separately supported improvement depreciation deductions of $45,000, $25,000, $15,000 are expressly nonoverlapping and not already excluded from cost new. Add supported site value of $125,000, already reflecting any site losses. What total indicated value results?
Which two depreciation categories may each be classified as curable or incurable by comparing the cost to remedy a deficiency with the value gained?
Improvement cost new is $800,000. Separately supported improvement depreciation deductions of $120,000, $80,000, $40,000 are expressly nonoverlapping and not already excluded from cost new. No site is included. What depreciated improvement amount results?
The principle of anticipation in real estate valuation states that:
Which highest-and-best-use criterion addresses whether a proposed use is allowed by zoning and applicable legal restrictions?
Three comparables produce adjusted indications of $312,000, $309,000 and $315,000, requiring gross adjustments of 9%, 14% and 22% respectively. Verification also establishes that the first sale is the closest competitive substitute and its adjustments are better supported than the other two. Which indication deserves the most weight on those facts?
When reconciling value indications from the three approaches to value, an appraiser should:
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