Chapter 3

Question 1

Capitalization

Answer 1

The conversion of income into value

Question 2

What are two methods of capitalization that appraisers can perform?

Answer 2

1. Direct capitalization
2. Yield capitalization

Question 3

Gross Rent Multiplier (GRM)

Answer 3

ratio of the price of a real estate to its monthly rental income

Question 4

How to find GRM:

Answer 4

Sale price / total monthly rent for property = GRM

Question 5

Direct capitalization process formula

Answer 5

Gross rent per month x Gross rent multiplier = Value

Question 6

To find the indicated
capitalization rate for each sale:

Answer 6

NOI / the sale price = indicated capitalization rate

Question 7

Direct capitalization process formula

Answer 7

Net operating income / Overall capitalization rate = Value

Question 8

Potential gross income (PGI

Answer 8

The total [potential] income
attributable to property at full occupancy before vacancy and operating expenses are deducted

Question 9

Effective gross income (EGI)

Answer 9

The anticipated income from all
operations of the real estate after an allowance is made for vacancy and
collection losses and an addition is made for any other income

Question 10

Net operating income (NOI or IO)

Answer 10

The actual or anticipated net
income that remains after all operating expenses are deducted from effective gross income, but before mortgage debt service and book depreciation are deducted

Question 11

Pre-tax cash flow (PTCF)

Answer 11

The portion of net operating
income that remains after total mortgage debt service is paid but before income tax on operations is deducted; also called before-tax cash flow or equity dividend

Question 12

After-tax cash fl ow (ATCF)

Answer 12

The portion of pre-tax cash flow that remains after all income tax liabilities have been deducted

Question 13

Reversion

Answer 13

A lump-sum benefit that an investor
receives or expects to receive upon the termination or sale of an investment

Question 14

Overall Capitalization Rate (Ro)

Answer 14

The relationship between a single year’s net operating income expectancy and the total property price or value (Ro=Io/Vo)

Ex: property has NOI of 50k, sold for 500k

$50,000/$500,000=0.10 (10%)

Question 15

Equity capitalization rate (Re)

Answer 15

An income rate that reflects the
relationship between one year’s equity cash flow and the equity investment;
also called the cash-on-cash rate, cash flow rate, cash throw-off rate, or
equity dividend rate

(Re=Ie “Pre-tax Cash Flow”/Ve “Equity Invested”)

Question 16

Mortgage capitalization rate (Rm)

Answer 16

the ratio of the annual debt service to the remaining principal balance of the
mortgage loan

mortgage constant X number of payments per
year

Question 17

Interest rate

Answer 17

The rate of return, or yield, on debt capital

Question 18

Discount rate

Answer 18

A rate of return on capital used to convert future payments or receipts into present value

Question 19

Direct capitalization

Answer 19

A method that converts an estimate of a single year’s income expectancy, either by dividing the net income estimate by a capitalization rate or by
multiplying the income estimate by an appropriate factor.

Question 20

Yield capitalization

Answer 20

A method used to convert future benefits into present value by (1) discounting each future benefit at an appropriate yield rate, or
(2) developing an overall rate that explicitly reflects the investment’s income
pattern, holding period, value change, and yield rate

single year’s income estimate/capitalization rate

Question 21

Nominal interest rate (I)

Answer 21

A stated or contract rate; an interest rate, usually
annual, that does not necessarily correspond to the effective or compound
interest rate

Question 22

What does the purpose of an appraisal assignment define?

A. a summary of the scope of work decision
B. the definition of the client’s problem
C. the intended use of the assignment
D. the type and definition of value used in the assignment

Answer 22

D

Question 23

A value opinion of a proposed office building based on a current effective date
would generally require what kind of assignment condition?

A. a hypothetical condition
B. an extended limiting condition
C. an extraordinary assumption/special assumption
D. a standard assumption

Answer 23

A

Question 24

The ratio of annual debt service to the principal amount of the mortgage loan is
called the

A. discount rate.
B. equity capitalization rate.
C. interest rate.
D. mortgage capitalization rate.

Answer 24

D

Question 25

If the net operating income of a property is $187,500 and the market indicates
an overall capitalization rate of 7.5%, what is the indicated value using direct
capitalization?
A. $201,563
B. $328,125
C. $2,500,000
D. $2,678,571

Answer 25

C: $187,500 / 0.075 = $2,500,000

Question 26

What are the three traditional approaches to value?

A. cost, sales comparison, and income capitalization
B. income capitalization, sales comparison, and extraction
C. market analysis, highest and best use analysis, and cost analysis
D. sales comparison, extraction, and allocation

Answer 26

A

Question 27

What is the indicated overall capitalization rate of a property that sold for
$825,000 and has a net operating income of $53,625?

A. 0.063%
B. 0.15%
C. 6.5%
D. 15.38%

Answer 27

C: $53,625 / $825,000 = 0.065 (or 6.5%)

Question 28

What is the gross rent multiplier of a property that sold for $174,000 and has a
gross monthly rent of $1,500?

A. 8.6%
B. 98
C. 113
D. 116

Answer 28

D: $174,000 / $1,500 = 116 GRM

Question 29

The amount left after debt service has been deducted from net operating income
is called
A. after-tax cash flow.
B. discounted cash flow.
C. pre-tax cash flow.
D. reversion

Answer 29

C

Question 30

What method is used to convert an estimate of a single year’s income expectancy
into an indication of value?

A. direct capitalization
B. discounted cash fl ow analysis
C. reversion
D. yield capitalization

Answer 30

A

Question 31

Jackson is appraising a large tract of land that is being farmed for agricultural use.
The land use surrounding the farm is currently in transition from agricultural to
one-unit residential developments. For this assignment, what two procedures
should Jackson consider in analyzing the land value of the property?

A. extraction and allocation
B. ground rent capitalization and allocation
C. residual land technique and extraction
D. sales comparison and subdivision development analysis

Answer 31

D