Part 3

Question 1

The conversion of income into value.

Answer 1

Capitalization

Question 2

A method used to convert an estimate of a single year’s income expectancy into an indication of value in one direct step, either by dividing the net income estimate by an appropriate capitalization rate or by multiplying the income estimate by an appropriate factor.

Gross rent per month x Gross rent multiplier = Value. VIF formula

Net operating income / Overall capitalization rate = Value. IRV formula

Answer 2

Direct capitalization

1/2 methods of capitalization that appraisers can perform

Question 3

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.

Answer 3

Yield capitalization

2/2 methods of capitalization that appraisers can perform

Question 4

Direct capitalization is based on income over a one-year period, whereas yield capitalization is based on an income stream of more than one year.

True or false?

Answer 4

True, this is the key difference between direct capitalization and yield capitalization.

Question 5

An office building sold for $5,000,000. It had net operating income of $500,000. The indicated overall rate is 10%.

True or false?

Answer 5

True. Apply IRV. Divide net operating income by sales price. $500,000 / $5,000,000 = .10 or 10% overall rate.

Example of direct capitalization process using IRV

1/2 basic formulas used in direct capitalization

Question 6

If a property has gross income of $10,000, and the gross income multiplier is 9, the estimated value of the property is $111,111.

True or False?

Answer 6

False. Apply VIF. Multiply gross income by gross income multiplier. $10,000 x 9 = $90,000.

Example of direct capitalization process using VIF

2/2 basic formulas used in direct capitalization

Question 7

The first step in yield capitalization is to analyze the subject’s income stream. A pharmacy has a building size of 13,000 sq ft. It is in the last five years of its lease and has a flat rent over the remaining term. The NOI is $150,000 each year over the holding period. If the appraiser’s research indicates a discount rate of 10%, what is the present value of this income stream based on annual compounding?

Answer 7

• Press the gold f and CLX keys to clear any previous entries in your HP 12C calculator.
• The holding period is five years, so we enter 5 n into your calculator.
• As stated, the rate is 10%, so we enter 10 i
• Recall that NOI is $150,000 each year. We enter 150000 CHS for PMT.
• To calculate the present value of the income stream, press PV.

Present value of this income stream based on annual compounding is $568,618.02

Example of yield capitalization process part 1

Question 8

The second step is to analyze the reversion or lump sum benefit to an investor of the property. If the appraiser’s research indicates a value of $2.1 million at the end of the holding period, what is the present value of the reversion (assuming we stay with an annual discount rate of 10%)?

Answer 8

• Press the gold f and CLX keys to clear any previous entries in your HP 12C calculator.
• The future value (FV) is 2.1MM, so we enter 2,100,000 CHS FV
• The holding period is five years, so we enter 5 n into your calculator.
• As stated, the rate is 10%, so we enter 10 i

HP12C Keystrokes: 2100000 CHS FV > 5 n > 10 i > PV > equals $1,303,934.78

Now to arrive at the indicated value in yield capitalization, we need to add the income stream to the reversion. What is the indicated value of the property?

Press the gold f and CLX keys to clear any previous entries in your HP 12C calculator.

HP12C Keystrokes:
568,618.02 Enter 1,303,934.78 + > equals 1,872,552.80, or $1,873,000

Example of yield capitalization process part 2

Question 9

What principle is the basis of the income capitalization approach?

This question was on the quiz.

Answer 9

Anticipation.

in that value is the present worth of anticipated future benefits. These future benefits include all benefits to be received over the projection period, such as annual income plus the right to the proceeds of the sale of the property in the future.

Question 10

1. Highest and best use
2. Anticipation and change
3. Supply and demand
4. Substitution
5. Balance
6. Externalities

These are the six __________ and __________ __________ that are influential to the income capitalization apporach

Answer 10

Concepts and economic principles

Question 11

1. Potential gross income (PGI)
2. Effective gross income (EGI)
3. Net operating income (NOI)
4. Pre-tax cash flow (PTCF)
5. After-tax cash flow (ATCF)
6. Reversion

These are the six commonly used __________ of __________ __________

Answer 11

measures of future benefits

Question 12

Which of the following describes the term, “pre-tax cash flow?”

This question was on the quiz.

Answer 12

net operating income less debt service

2/6 Measures of Future Benefits

When debt service is deducted from net operating income, the result is pre-tax cash flow.

Question 13

On which of the following types of income is direct capitalization based?

This question was on the quiz.

Answer 13

a single year’s income

Direct capitalization using the I/R=V formula is based on the next 12 months of anticipated net operating income or, in other words, a single year’s income.

Question 14

What does GRM refer to in the appraiser’s analysis of a residential income property?

This question was on the quiz.

Answer 14

gross rent multiplier

GRM is a factor derived from the market and is multiplied by the gross rent to provide a value indicator for the appraised property.

Question 15

How is reversion in an investment property defined?

This question was on the quiz.

Answer 15

a lump sum benefit that an investor receives or expects to receive at the termination of an investment

1/6 Measures of Future Benefits

Question 16

The total [potential] income attributable to property at full occupancy before vacancy and operating expenses are deducted. (The word potential was added to the definition.)

Answer 16

Potential gross income (PGI)

3/6 Measures of Future Benefits

Question 17

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

Answer 17

Net operating income (NOI, IO)

4/6 Measures of Future Benefits

Question 18

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

Answer 18

after-tax cash flow (ATCF)

5/6 Measures of Future Benefits

Question 19

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.

Answer 19

effective gross income (EGI)

6/6 Measures of Future Benefits

Question 20

A ratio of one year’s net operating income provided by an asset to the value of the asset; used to convert income into value in the application of the income capitalization approach.

Answer 20

Capitalization rate (R)

Question 21

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

Answer 21

Overall capitalization rate (Ro)

Question 22

What characteristics based on market value are identifiable in an income producing property?

This question was on the quiz.

Answer 22

has objective, impersonal parameter, and also reflects what typical investors in the market might do

Terms and Definitions: Market and Investment Value

Question 23

The income capitalization approach is generally not applicable to which of the following property types?

This question was on the quiz.

Answer 23

one-unit homes that are owner-occupied

Typically, an owner-occupied residence is not purchased for investment or for producing income.

Question 24

What are the two primary methods of income capitalization that are differentiated by the duration of their income streams?

This question was on the quiz.

Answer 24

direct capitalization and yield capitalization

Direct capitalization analyzes the income for a one-year period, whereas yield capitalization looks at the income stream for a period greater than one year.

Question 25

Which of the following best describes the term, “investment value”?

Answer 25

value to a particular investor, based on personal, subjective parameters

Investment value is the value to a particular investor, based on subjective and personal parameters, and may be different from typical investors in the market.