In a DCF using an explicitly forward-income terminal model, what income is normally capitalized at the end-of-hold sale?
Correct Answer
C) The forecast stabilized NOI for the first year after the sale date.
A common terminal-price model capitalizes the first stabilized income after sale at a supported exit rate, then accounts for selling costs as appropriate and discounts the dated net proceeds. This is not the only permissible terminal model, and the timing must match the forecast.
Why This Is the Correct Answer
Option C is correct because a forward-income terminal model capitalizes the forecast stabilized NOI for the first year after the sale date at a supported terminal rate. For example, with a 5-year hold, year 6 income is capitalized.
Why the Other Options Are Wrong
Option A: Acquisition-year NOI at the going-in rate.
Option A, capitalizing acquisition-year NOI at the going-in rate, ignores income changes over the holding period and the terminal rate selection. The reversion should reflect income expected after the sale, not at purchase.
Option B: Original price plus an unsupported inflation increment.
Option B, original price plus an unsupported inflation increment, is not a capitalization of income at all. A reversion estimate needs supported income and rate inputs rather than an arbitrary markup.
Option D: Zero, since the property is sold at the end of the holding period.
Option D, zero because the property is sold at the end of the holding period, misunderstands the reversion. The sale itself produces proceeds that a DCF includes and discounts to present value.
Hold plus one
For a forward-income reversion, capitalize the income for the year after the hold: a 5-year hold uses year 6 income.
How to use: Use this to pick the income year for a terminal value calculation.
Exam Tip
Look for the phrase forward income; it signals that the next year's forecast income, not the final holding-year income, is capitalized.
Common Mistakes to Avoid
- -Capitalizing the final holding-year income under a forward-income model
- -Using the going-in rate as the terminal rate without support
- -Omitting the reversion from the DCF
Concept Deep Dive
Analysis
This question tests the forward-income convention for estimating a reversion in a DCF. Under this model, the income capitalized at sale is the forecast stabilized NOI for the year after the holding period ends. That reflects the income a buyer would expect in the first year of ownership.
Background Knowledge
In a DCF, the reversion is often estimated by capitalizing the income forecast for the year following the holding period at a terminal capitalization rate. The resulting terminal value, less selling costs as appropriate, is discounted to present value. Other terminal models exist, but timing must be consistent with the forecast.
Real-World Application
An appraiser building a 10-year DCF for an apartment complex forecasts year 11 NOI and divides it by a market-supported terminal cap rate. Selling costs are deducted and the net proceeds are discounted back to the valuation date.
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
An appraiser finds a comparable that sold for a cash-equivalent price of $1,350,000 with annual PGI of $150,000. The subject has annual PGI of $128,000. Sales in the market area indicate the subject would sell at the same price-to-income ratio, and no other adjustments are needed. What is the indicated value of the subject, to the nearest dollar?
Next Question
An appraiser is valuing a fourplex with effective gross income of $110,000 and has found three cash-equivalent sales. Sale A sold for $720,000 with EGI of $90,000. Sale B sold for $820,000 with EGI of $100,000. Sale C sold for $850,000 with net operating income of $85,000; its EGI could not be verified. The appraiser averages the effective gross income multipliers available from the sales. What is the indicated value?