Lesson 6 Exercises – Characteristics of the Income Stream (The Income Approach to Value)

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  1. Which of the following are components of the income stream:
    1. Return on investment and return of investment
    2. Component to provide for all property related expenses
    3. Component to provide for payment of property taxes
    4. All of the above

    d. All of the above

    Explanation: Investors of income producing properties anticipate that the future income from the property will satisfy different functions and therefore the income stream can be separated into various components: a component to provide for all property related expenses, including vacancy and collection losses, maintenance and repair, and utilities; a component to provide for the payment of the property taxes on the property; a component to allow for the return OF the investment; and a component to allow for a return ON the investment.

  2. Vacancy and collection loss:
    1. Is an allowance for reductions in gross income due to vacancy and nonpayment of rent
    2. Is typically anticipated by investors during the life of the property
    3. Are expressed as a percentage of potential gross income
    4. All of the above

    d. All of the above

    Explanation: Vacancy and collection loss is an allowance for reductions in gross income that may occur due to vacancies and tenant turnover in the property or for tenants that do not pay the rent due. Typically, an investor will anticipate that the property will experience some vacancy or collection losses during the remaining economic life of the property. Even when a property has a history of no vacancy and collection loss, it is prudent to anticipate that a loss will occur at some point in the future. Vacancy and collection losses are usually expressed as a percentage of potential gross income.

  3. Property expenses include:
    1. Fixed expenses
    2. Variable expenses
    3. Vacancy and collection loss
    4. All of the above
    5. A and B

    e. A and B

    Explanation: Property expenses are those operating expenses necessary to maintain or insure an income stream. They include fixed expenses (such as building insurance), variable expenses (such as repairs and utilities), and reserves for replacements (such as allowance to replace a roof). Property expenses do not include vacancy and collection loss which is expressed as a percentage of potential gross income.

  4. The term holding period usually refers to the:
    1. Time span in which improvements continue to contribute to value
    2. Period of time over which net income remains greater than operating expenses
    3. Time span of ownership
    4. Period of time that has elapsed since construction of the improvements

    c. Time span of ownership

    Explanation: The term holding period refers to the time span of ownership

  5. Investors are typically interested in:
    1. Return of their investment
    2. Return on their investment
    3. Both of the above
    4. None of the above

    c. Both of the above

    Explanation: An investor will expect an investment to cover expenses, provide income to recapture the amount invested, and provide a return on the investment.

  6. Which income stream shape best represents vacant land?
    1. Level Terminal
    2. Straight-line Declining Terminal
    3. Constant Perpetual
    4. None of the above

    c. Constant Perpetual

    Explanation: Constant perpetual income stream is the shape usually associated with vacant land. Constant perpetual a series of equal periodic income payments received regularly over a period of time; the assumption is that payments will continue into perpetuity. Because land is a non-wasting asset, there is no need to allow for a return OF the investment; therefore land is considered to be capable of producing a constant perpetual income.

  7. Which income stream shape best describes a series of income that declines in equal amounts over a period of time then ends?
    1. Constant perpetual terminal
    2. Straight-line declining terminal
    3. Level terminal
    4. None of the above

    b. Straight-line declining terminal

    Explanation: Straight-line declining terminal is a series of income that declines in equal amounts over a period of time then terminates. Recapture Of the investment is equal over time until it terminates; and return ON decreases gradually each year. Constant perpetual terminal is not one of the five shapes of an income stream; one of the shapes is properly named “constant perpetual.” A level terminal income stream is a series of equal, annual incomes that terminate at some point in the future.

  8. In a level terminal income stream:
    1. Annual incomes are equal then end at some point in the future.
    2. It is normally associated with improvements.
    3. Return on investment increases over the holding period.
    4. All of the above

    d. All of the above

    Explanation: Level terminal is a series of equal, annual incomes that terminate at some point in the future. The return On investment increases annually over the holding period with recapture Of investment, also increasing over time, allowed for through a procedure that is based on a sinking fund recapture. Terminal income streams are normally associated with wasting assets (improvements.)