Unlike the land residual method, why does ground rent capitalization not deduct income attributable to improvements?
Correct Answer
D) Because ground rent is income imputable to the land alone
Since ground rent by definition is income imputable only to the land, no income attributable to improvements is subtracted as in the land residual method.
Why This Is the Correct Answer
Option D is correct because ground rent is by definition income imputable to the land alone. Since no part of it belongs to the improvements, nothing attributable to improvements needs to be subtracted before capitalizing it. In the land residual method, by contrast, total income includes the building's share, which must be deducted.
Why the Other Options Are Wrong
Option A: Because ground leases do not permit buildings on the site
Option A says ground leases do not permit buildings on the site. Ground leases commonly allow the tenant to build; the reason for no deduction is that the rent is paid for the land.
Option B: Because the improvements are valued later by extraction
Option B says the improvements are valued later by extraction. That is not why no deduction is made; the rent itself already excludes the improvements.
Option C: Because the land capitalization rate already includes them
Option C says the land capitalization rate already includes the improvements. A land rate applies to land income; the reason for no deduction is that ground rent is land income only.
Ground rent is land-only rent
Ground rent pays for the dirt, not the building, so there is no building income to strip out before capitalizing.
How to use: Use this to explain why ground rent capitalization skips the building deduction.
Exam Tip
When a question contrasts ground rent capitalization with land residual, look for the answer about what the income represents.
Common Mistakes to Avoid
- -Believing ground leases prohibit improvements
- -Deducting building income from ground rent
- -Thinking the land rate absorbs the improvements
Concept Deep Dive
Analysis
This question tests why ground rent capitalization differs from the land residual method. The land residual method starts with total property income and must remove the building's share. Ground rent is already income paid for the land, so there is no building income to remove.
Background Knowledge
Ground rent capitalization converts the rent paid for the use of land into a land value by applying a land capitalization rate. The land residual method instead begins with income from the whole property and subtracts the income attributable to improvements. The difference lies in what the starting income represents.
Real-World Application
An appraiser values a parcel under a long-term ground lease on which the tenant built a restaurant. The appraiser capitalizes the ground rent at a supported land rate without deducting anything for the restaurant, because the tenant's building income is not part of the ground rent.
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Previous Question
Which describes extraction as distinct from applying a land-to-total allocation ratio?
Next Question
A competitive improved property sold for $1,050,000, and the applicable land-to-total value ratio is 24%. Separately, a whole-property value indication is $1,100,000, with a depreciated improvement contribution of $820,000. What are the land indications by allocation and by extraction, respectively?