Chapter 10 - Income Approach and Capitalization Flashcards

Chapter 10 - Income Approach and Capitalization Flashcards what is the income approacha valuation method used to estimate the value of income-producing real estate The income capitalization formula can be converted to similar equations (3) that solve for a property's cap rate or income.(1) Income/Rate = Value(2) Income/Value = Rate(3) Value x Rate = Income The rate of the return on an investment is known ascapitalization rate Acceptable methods for completing direct capitalization include all of the following EXCEPT which?A.) Comparable method and investment/income methodB.) Accounts profile method and development/residual methodsC.) The cost approach methodD.) Contractor's/cost method C.) The cost approach method What types of properties is the income approach used to value?A.) Residential properties onlyB.) Residential and commercial propertiesC.) Investment and residential propertiesD.) Commercial and investment properties D.) Commercial and investment properties The formula for determining the gross income multiplier is:Sales price / gross annual income = gross income multiplier if a home sold for $95,000 and the monthly rental income was $950, the gross rent multiplier would be what

$95,000 / $975 = 97/4 GRM

Explain gross rent multiplier (GRM)The ratio of monthly/yearly rent divided into the properties selling price.Explain the accounts method / profits method Used for trading properties where there is little existing or available rate-specific evidence.Restaurants, nursing homes, and hotels.What types of expenses are NOT considered operating expenses Operating expenses do not include debt service, expenditures for capital improvements, or expenses not related to operation of the property.Explain contractors method (cost method) Only used to value properties that are not sold or purchased on the market.The formula for determining the gross rent multiplier is:sales price / gross rent = gross rent multiplier TRUE OR FALSEIf the appraiser seeks to identify value, he or she divides the cap rate into net operating income.

TRUE Five steps to creating a value estimate using the income

approach:

(1) estimate the potential gross income(2) Estimate effective gross income.(3) Calculate the net operating income.(4) Select a capitalization rate.(5) Apply the capitalization rate.Disadvantages of the income approach:(1) Sometimes necessary, relevant information is not available or readily accessible from internal reporting systems.(2) It requires subjective cash flow allocation.(3) By translating theory into practice, the appraiser is forced to use limiting assumptions.

explain development method (residual method) Only used to value bare land or properties that are immediately ready for development/redevelopment Explain the comparable method (sales comparison approach) used for most property types, as long as there is sufficient evidence of previous sales.Acceptable methods of calculating income approach (1) direct capitalization(2) gross income multiplier(3) discounted cash flow if a property sold for $185,000 and the annual gross income was $11,400, the gross income multiplier would be

$185,000 / $11,400 = 16.22 GIM

A property is estimated to produce a net operating income of $1,000,000. Which of the following capitalization rates would produce the greatest estimated value for the property?A.) 5%B.) 6%C.) 7%D.) 8%

A.) 5%

the income approach of valuation relates the following two

factors to value:

(1) Market rent (rent that a property can be expected to earn during of its life)(2) Reversion (resale amount when the property is sold).To the real estate appraiser, the income approach attempts toA.) indicate the most probable investment expenditure.B.) calculate how much money this property can be expected to earn in the future.C.) assist in determining highest and best use.D.) calculate the net operating income.B.) calculate how much money this property can be expected to earn in the future.The appraiser who uses direct capitalization to appraise income-producing real estate must do what.....must use the equation's NOI, the real estate's (NOT the business interests') net income, along with non-cash items and interest expense.Capitalization rate is determined by what Extracting and then applying the sales of similar investment properties to the subject property's net income.When would an appraiser use gross rent multiplier (GRM) or gross income multiplier (GIM) Appraisers use these approaches to estimate the value of properties such as single-family homes and duplexes that could produce income, but are not primarily income-producing properties like apartment buildings and office space.The 5 methods of direct capitalization(1) contractors method (cost method)(2) Development method (residual method)(3) Comparable method (sales comparison approach)(4) investment method / income method(5) Accounts method / profits method After estimating the property's annual potential gross income, then deducting an appropriate, market-based allowance for losses due to vacancies and collections, the remainder is termed what The properties effective gross income.The income approach is most common with (2) (1) commercial real estate appraisals(2) Business appraisals What principle of value is the basis for the income approach Anticipation.what are the 2 forms of income producing real estatecommercial properties and investment properties.Once the appraiser has calculated the GRM of several comparable properties that have recently sold, he or she

can determine the value of the subject property by multiplying a selected GRM by the subject's monthly

income.This is displayed as:

Monthly Rent x GRM = Estimated Value

An appraiser who uses direction capitalization to appraise a complex property, or a property that has unusual factors that require a risk adjustment must to what.....must use a risk adjusted-cap rate A property is being appraised using the income capitalization approach. Annually, it has an estimated gross income of $30,000, vacancy and credit losses of $1,500, and operating expenses of $10,000. Using a capitalization rate of nine percent, what is the indicated value (to the nearest $1,000)?A.) $206,000B.) $167,000C.) $222,000D.)

$180,000

A.) $206,000Net operating income ÷ capitalization rate = value.Gross Income - Expenses - Vacancy and CreditLosses = Net Operating Income.$30,000 - $1,500 - $10,000 = 18,500. $18,500 net operating income ÷ 9% cap rate = $205,556, which is rounded to $206,000.When the income approach method is used for a single-family residence,A.) the appraisal is considered the most accurate.B.) the method is considered less effective than other appraisal approaches.C.) the appraisal carries more weight than other methods.D.) the value determined is as accurate and effective as other methods.B.) the method is considered less effective than other appraisal approaches.The simplest and most widely used form of capitalization isDirect capitalization Explain investment method / income method used for most rent-producing (leased) commercial (and residential) property What is the definition of capitalization rate The rate of return on an investment.Advantages of the income approach:(1) There is no need for market transactions because this approach does not use comparable market info, but instead, gathers the future returns from the owner.(2) This approach illustrates the relationship between the returns of investment on a security and the returns on the overall market portfolio.This approach uses forecasted cash flows or technology-generated earnings (or tech-related cost savings).(3) This approach uses the capitalization technique to calculate the systematical component of risk.(4) This approach uses the IP asset's discounted rate - which considered the systematic risk - to calculate the present value of its cash flows.