Real Estate Principles: A Value Approach, 5e (Ling)

Chapter 8 Valuation Using the Income Approach

1) Which of the following measures is considered the fundamental determinant of market value
for income-producing properties?
A) net operating income
B) potential gross income
C) operating expenses
D) capital expenditures

Answer: A
2) Net operating income is similar to which of the following measures of cash flow in corporate
finance?
A) dividend yield
B) earnings before deductions for interest, depreciation, income taxes, and amortization
(EBIDTA)
C) price-earnings ratio
D) discount rate

Answer: B
3) The process of converting periodic income into a value estimate is referred to as income
capitalization. Income capitalization models can generally be categorized as either direct
capitalization models or discounted cash flow models. Which of the following statements best
describes the direct capitalization method?
A) Value estimates are based on a multiple of expected first-year net operating income.
B) Appraisers must make explicit forecasts of the property's net operating income for each year
of the expected holding period.
C) Appraisers must select the appropriate yield at which to discount future cash flows.
D) The forecast must include the net income produced by a sale of the property at the end of the
expected holding period.

Answer: A
4) The starting point in calculating net operating income is the total annual income the property
would produce assuming 100% occupancy and no collection losses. This is commonly referred
to as
A) effective gross income.
B) potential gross income.
C) operating expenses.
D) capital expenditures.

Answer: B
5) The distinction between market rent and contract rent is important due to differences in lease
terms. Office, retail, and industrial tenants most commonly occupy their space under leases that
run
A) one year or less.
B) one to three years.
C) three to five years.
D) ten years or more.
Answer: C
6) One complication that appraisers may face is the variety of lease types that may be available
for a particular property type. Which of the following statements best describes a graduated or
step-up lease?
A) The monthly rent remains fixed over the entire lease term.
B) The lease establishes a schedule of rental rate increases over the term of the lease.
C) Rental rate increases are indexed to the general rate of inflation.
D) Rental rates are a function of the sales of the tenant's business.

Answer: B
7) In calculating net operating income, vacancy losses must be subtracted from the gross income
collected. The normal range for vacancy and collection losses for apartment, office, and retail
properties is
A) between 0% and 1%.
B) between 1% and 5%.
C) between 5% and 15%.
D) between 15% and 20%.

Answer: C
8) The expected costs to make replacements, alterations, or improvements to a building that
materially prolong its life and increase its value is referred to as
A) operating expenses.
B) capital expenditures.
C) vacancy losses.
D) collection losses.

Answer: B
9) Operating expenses can be divided into two categories: variable and fixed expenses. Which of
the following best exemplifies a fixed expense?
A) utilities
B) property management
C) local property taxes
D) trash removal

Answer: C
10) Which of these is most likely to be regarded as a capital expenditure rather than an operating
expense?
A) property taxes
B) trash removal
C) insurance payments
D) roof replacement

Answer: D
11) Most appraisers adhere to an "above-line" treatment of capital expenditures. This implies
which of the following?
A) Capital expenditures are subtracted in the calculation of net operating income.
B) Capital expenditures are subtracted from net operating income to obtain a net cash flow
measure.
C) Capital expenditures are added to net operating income.
D) Capital expenditures are excluded from all calculations because they are difficult to estimate.

Answer: A
2) The going-in cap rate, or overall capitalization rate, is a measure of the relationship between a
property's current income stream and its price or value. Which of the following statements
regarding cap rates is true?
A) It is a measure of total return since it accounts for future cash flows from operations and
expected appreciation (depreciation) in the market value of the property.
B) It is a discount rate that can be applied to future cash flows.
C) It is analogous to the dividend yield on a common stock.
D) It is the projected rate at which prices will appreciate in the future.

Answer: C
13) For smaller income-producing properties, appraisers may use the ratio of a property's selling
price to its effective gross income. This is an example of a
A) net operating income.
B) going-out cap rate.
C) going-in cap rate.
D) gross income multiplier.

Answer: D
4) Gross income multiplier analysis assumes that the subject and comparable properties are
collecting market rents. Therefore, it is frequently argued that an income multiplier approach to
valuation is most appropriate for properties with short-term leases. For which of the following
property types, therefore, would we find it most appealing to use a gross-income multiplier in
our analysis?
A) apartments
B) office
C) industrial
D)retail

Answer: A
15) When using discounted cash flow analysis for valuation, the appraiser must estimate the sale
price at the end of the expected holding period. This price (assuming selling expenses have yet to
be accounted for) is referred to as the property's
A) net sale proceeds.
B) selling expenses.
C) terminal value.
D) current market value.

Answer: C
16) When using discounted cash flow analysis for valuation, an appraiser will prepare a cash
flow forecast, often referred to as a
A) restricted appraisal report.
B) net operating income statement.
C) direct market extraction.
D) pro forma.

Answer: D
17) When calculating the net operating income of a property, it is important to identify any
expenses that will be incurred in attempts to maintain the property. All of the following would be
considered operating expenses except
A) property insurance premiums.
B) mortgage payments.
C) utility expenses.
D) property taxes.

Answer: C
18) The cap rate is an important metric that investors use to analyze the state of commercial real
estate markets. When interpreting cap rate movements, an increase in cap rates over time would
indicate that
A) the discount rate used in TVM (time value of money) calculations has increased.
B) the discount rate used in TVM (time value of money) calculations has decreased.
C) property values have increased.
D) property values have decreased.

Answer: D
19) Given the following information, calculate the overall capitalization rate: sale price:
$950,000; potential gross income: $250,000; vacancy and collection losses: $50,000; and
operating expenses: $50,000.
A) 15.8%
B) 21.1%
C) 26.3%
D) 36.8%

Answer: A
20) Given the following information, calculate the net operating income assuming below-line
treatment of capital expenditures: property: 4 office units, contract rents per unit: $2,500 per
month; vacancy and collection losses: 15%; operating expenses: $42,000; capital expenditures:
10%.
A) $48,000
B) $60,000
C) $95,000
D) $102,000

Answer: B
21) Given the following information, calculate the effective gross income: property: 4 office
units, contract rents per unit: $2,500 per month; vacancy and collection losses: 15%; operating
expenses: $42,000; capital expenditures: 10%.
A) $100,000
B) $102,000
C) $120,000
D) $135,000

Answer: B
22) Given the following information, calculate the effective gross income multiplier: sale price:
$950,000; potential gross income: $250,000; vacancy and collection losses: 15%; and
miscellaneous income: $50,000.
A) 0.36
B) 0.30
C) 2.8
D) 3.6

Answer: D
23) Given the following information, calculate the appropriate going-in cap rate using mortgage-
equity rate analysis; mortgage financing, 75%; typical debt financing cap rate: 10%; sale price:
$1,950,000; before tax cash flow (BTCF): $390,000.
A) 9.6%
B) 10%
C) 12.5%
D) 13.6%

Answer: C
24) Given the following information, calculate the appropriate going-in cap rate using general
constant-growth formula: overall market discount rate, 12%; constant growth rate projection: 3%
per year; sale price: $1,950,000; net operating income: $390,000; potential gross income:
$520,000.
A) 8%
B) 9%
C) 10%
D) 11.5%

Answer: B
25) Given the following information, calculate the effective gross income multiplier: sale price:
$2,500,000; effective gross income: $340,000; operating expenses: $100,000; capital
expenditures: $36,000.
A) 0.136
B) 7.35
C) 10.42
D) 12.25

Answer: B
26) Three highly similar and competitive income-producing properties within two blocks of the
subject property have sold this month. All three offer essentially the same amenities and services
as the subject property. The sale prices and estimated first-year NOI for each of the comparable
properties are as follows: 

Comparable Sale Price NOI1

A $500,000 $55,000
B $420,000 $50,400
C $475,000 $53,400
Using the information provided, calculate the overall capitalization rate by direct market
extraction assuming each property is equally comparable to the subject.
A) 11.0%
B) 11.2%
C) 11.4%
D) 12.0%

Answer: C
27) Suppose that you are attempting to value an income-producing property using the direct
capitalization approach. Using data from comparable properties, you have determined the overall
capitalization rate to be 11.44%. If the projected first-year net operating income (NOI) for the
subject property is $44,500, what is the indicated value of the subject using direct capitalization?
A) $49,590.80
B) $50,225.73
C) $388,986.00
D) $509,080.00

Answer: C
28) Suppose that an income-producing property is expected to yield cash flows for the owner of
$10,000 in each of the next five years, with cash flows being received at the end of each period.
If the opportunity cost of investment is 12% annually and the property can be sold for $100,000
at the end of the fifth year, determine the value of the property today.
A) $36, 047.76
B) $56,742.69
C) $83,333.33
D) $92,790.45

Answer: D
29) Suppose that examination of a pro forma reveals that the fifth-year net operating income
(NOI) for an income-producing property that you are analyzing is $138,446 (you can assume that
this cash flow occurs at the end of the year). If you estimate the projected rental growth rate for
the property to be 5% per year, determine the projected sale price of the property at the end of
year 5 if the going-out capitalization rate is 9%.
A) $988,900.00
B) $1,465,037.00
C) $1,538,289.00
D) $1,615,203.00

Answer: D
30) Analysis of a subject property's pro forma reveals that its fifth-year net operating income
(NOI) is projected to be $100,282 (you can assume that this cash flow occurs at the end of the
year). If you estimate the projected rental growth rate for the property to be 3% per year and the
going-out capitalization rate in year 5 to be 10%, determine the net sale proceeds the current
owner of the property would receive if he were to sell the property at the end of year 5 and incur
selling expenses that amounted to $58,300.
A) $944,520.00
B) $974,610.00
C) $1,002,820.00
D) $1,032,910.00

Answer: B
31) Four highly similar and competitive income-producing properties located in close proximity
to the subject property have sold this month. All four offer essentially the same amenities and
services as the subject property. The sale prices and estimated first-year NOI for each of the
comparable properties are as follows:

Comparable Sale Price NOI1

A $1,450,000 $155,000
B $1,100,000 $135,400
C $1,250,000 $143,400
D $1,500,000 $169,000

Using the information provided, calculate the overall capitalization rate by direct market
extraction assuming each property is equally comparable to the subject.
A) 10.69%
B) 11.02%
C) 11.43%
D) 12.52%

Answer: C
32) Using the following information, determine the net operating income (NOI) for the first year of
operations of the subject property assuming "below-line" treatment of capital expenditures.

Subject Property
Number of apartments 15
Market rent (per month) 1000
Vacancy and collection losses 10% of PGI
Operating expenses 5% of EGI
Capital expenditures 10% of EGI

A) $135,000
B) $137,700
C) $153,900
D) $162,000
Answer: C
33) Using the following information, determine the net operating income (NOI) for the first year
of operations of the subject property using "above-line" treatment of capital expenditures.

Subject Property
Number of apartments 15
Market rent (per month) 1000
Vacancy and collection losses 10% of PGI
Operating expenses 5% of EGI
Capital expenditures 10% of EGI

A) $135,000
B) $137,700
C) $153,900
D) $162,000

Answer: B
34) Suppose that you are attempting to value an income-producing property using the direct
capitalization approach. Using data from comparable properties, you have determined the overall
capitalization rate to be 7.5%. If the projected first-year net operating income (NOI) for the
subject property is $135,500, what is the indicated value of the subject using direct
capitalization?
A) $144,985.00
B) $150,555.56
C) $1,806,666.67
D) $9,033,333.33

Answer: C
35) Suppose that an income-producing property is expected to yield cash flows for the owner of
$150,000 in each of the next five years, with cash flows being received at the end of each period.
If the opportunity cost of investment is 8% annually and the property can be sold for $1,250,000
at the end of the fifth year, determine the value of the property today.
A) $304,704.00
B) $1,449,635.50
C) $1,481,143.98
D) $2,000,000.00

Answer: B
36) Suppose that examination of a pro forma reveals that the fifth-year net operating income
(NOI) for an income-producing property that you are analyzing is $913,058 (you can assume that
this cash flow occurs at the end of the year). If you estimate the projected rental growth rate for
the property to be 3% per year, determine the projected sale price of the property at the end of
year 5 if the going-out capitalization rate is 8%.
A) $1,603,600
B) $2,350,159
C) $11,413,225
D) $11,755,622 answer: D