What distinguishes the building residual technique from the land residual technique?
Correct Answer
B) The building technique starts from a known land value
In the income building-residual technique, supported land value and its income rate identify land income; subtract that from compatible total NOI and capitalize the remaining building income. Income land residual starts instead with supported building value and building income rate.
Why This Is the Correct Answer
Option B is correct because the building residual technique is used when the value of the land is known but the value of the improvements is unknown. The appraiser multiplies the supported land value by the land capitalization rate to find the income attributable to land, subtracts that from total net operating income, and capitalizes the remaining building income at the building rate. The land residual technique instead starts from a known building value.
Why the Other Options Are Wrong
Option A: The building technique may only be used on new construction
Option A says the building technique may only be used on new construction. The technique depends on having a supported land value and reliable income data, not on the age of the building.
Option C: The building technique needs no capitalization rate at all
Option C says the building technique needs no capitalization rate at all. In fact it uses a land rate to find land income and a building rate to capitalize the residual building income.
Option D: The building technique applies one rate to both components
Option D says the building technique applies one rate to both components. Residual techniques separate the land and building components and generally apply separate rates, with the building rate reflecting capital recovery for a wasting asset.
Name the unknown component
The residual technique is named for the component left over and solved for. Building residual solves for the building, so land must be the known starting value.
How to use: Use this to decide which value is known when a question names a residual technique.
Exam Tip
The name of the residual technique tells you what is being solved for, so the other component is the one that must already be known.
Common Mistakes to Avoid
- -Thinking building residual starts from a known building value
- -Applying a single overall rate to both land and building income
- -Forgetting to subtract land income before capitalizing building income
Concept Deep Dive
Analysis
This question tests the starting point of the two physical residual techniques in income capitalization. The building residual technique is used when land value is known and building value is unknown; the land residual technique is the reverse. Identify which component is known and which is solved for.
Background Knowledge
Residual techniques split net operating income between land and building. One component's value is known, its income share is calculated with its capitalization rate, and the remaining income is capitalized to value the unknown component. These techniques rely heavily on the accuracy of the known value and the rates used.
Real-World Application
An appraiser values an older income property in a district with many recent vacant land sales that support a reliable land value. The appraiser uses the building residual technique to estimate the contribution of the improvements from the income left after the land's share is removed.
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