In a land/building residual calculation with the value and capitalization rate of one component known, what is the defining step?
Correct Answer
D) Deduct the known part’s income and capitalize the remainder.
The known component’s income is its supported value times its compatible rate. Subtract that income from the total and capitalize the residual at the unknown component’s compatible rate. Other residual techniques can separate debt and equity; land/building is not the only possible component split.
Why This Is the Correct Answer
Option D is correct because the defining step is to deduct the known component's income, its value times its rate, and capitalize the remaining income at the unknown component's rate. That residual income is what supports the unknown component. Adding the components then gives total value when required.
Why the Other Options Are Wrong
Option A: Eliminate the capitalization rates from the valuation.
Option A is wrong because residual techniques rely on capitalization rates for both components. Eliminating the capitalization rates would make it impossible to compute the known component's income or value the residual.
Option B: Require ten forecast years in the residual analysis.
Option B is wrong because a residual calculation does not require a ten-year forecast. It can be done with a single year's stabilized income and component rates.
Option C: Restrict the technique to owner-occupied single-family homes.
Option C is wrong because residual techniques are not restricted to owner-occupied single-family homes. They are typically used for income-producing properties where land and building, or debt and equity, can be separated.
Satisfy known, capitalize leftover
Pay the known component its income first, then the leftover income belongs to the unknown component.
How to use: Use this phrase to recall the core step of any residual technique.
Exam Tip
Answers about removing rates, fixed forecast lengths or property-type restrictions do not describe residual techniques. Look for the deduct-then-capitalize step.
Common Mistakes to Avoid
- -Capitalizing total NOI at a single component rate
- -Using the wrong component's rate for the residual
- -Thinking residual techniques apply only to land and building
Concept Deep Dive
Analysis
This question tests the mechanics that define land and building residual techniques. When one component's value and rate are known, the income it requires is deducted from total NOI. The leftover income is then capitalized at the other component's rate to value that component.
Background Knowledge
Residual techniques capitalize the income allocated to a component of unknown value once all components of known value have been satisfied. Physical residuals split land and building, while financial residuals split mortgage and equity. Each component's income is its value times its own compatible rate.
Real-World Application
An appraiser has a reliable building value from a recent cost estimate on new construction but weak land sales data. Using the land residual technique, the appraiser deducts the building's required income and capitalizes the remainder to estimate land value.
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?
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Previous Question
The subject property is a fourplex with three one-bedroom units and one two-bedroom unit. Market rent is $1,100 per month for a one-bedroom unit and $1,400 per month for a two-bedroom unit. Stabilized vacancy and credit loss is 5% of PGI, annual operating expenses are $19,580, and the market overall rate is 8%. What is the indicated value by direct capitalization?
Next Question
The operating expense ratio for the subject property is 28% of its annual effective gross income of $525,000. The overall capitalization rate is 9%. What value is indicated by direct capitalization, to the nearest dollar?