Lesson 8 Exercises – Capitalization: Converting an Income Stream into Value (The Income Approach to Value)

Appraisal Training: Self-Paced Online Learning Session

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• Lesson 13
• Lesson 14
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• Exam

Check Your Knowledge

1. Capitalization is the process of:
   1. Forecasting future yields of a property
   2. Calculating value from price
   3. Deducting expenses to find net assets
   4. Converting an income stream into a value indicator

Solution:

2. Which is a key variable of income capitalization?
   1. Capitalization rate used to convert a multiplier into value
   2. Capitalization rate or factor used to convert income into value
   3. Overall rate used to convert a multiplier into value
   4. None of the above

Solution:

3. In yield capitalization:
   1. You convert future benefits (income) into present value by dividing a single year's income estimate by an appropriate capitalization rate.
   2. You convert future benefits (income) into present value by discounting each future benefit at an appropriate yield rate.
   3. You convert future benefits (income) into present value by capitalizing each future benefit by an appropriate capitalization rate.
   4. Both a and b above

Solution:

4. In direct capitalization:
   1. You convert an estimate of a single year's income expectancy into present value by dividing the income expectancy by an appropriate rate or by multiplying the income estimate by an appropriate factor.
   2. You convert future benefits (income) into present value by discounting each future benefit at an appropriate yield rate.
   3. You convert future benefits (income) into present value by capitalizing each future benefit by an appropriate capitalization rate.
   4. Both a and b above

Solution:

5. If the subject property has a net operating income of $55,000, what is its indicated value using the capitalization rate of 0.1125?
   1. $367,000
   2. $400,000
   3. $489,000
   4. $550,000

Solution:

6. An investor purchases a rental home for $100,000. If they expect to receive a 6 percent return on their investment, how much is the annual rent they expect to receive?
   1. $3,000
   2. $6,000
   3. $1,666,667
   4. $500

Solution:

7. A property with a net operating income of $30,500 was appraised at $350,000.  At what rate was the income capitalized (rounded to the nearest whole percentage)?
   1. 0.0085 =  1%
   2. 0.08 = 8%
   3. 0.09 = 9%
   4. 0.1148 = 11%

Solution:

8. A small apartment complex valued at $300,000 earns a monthly net income of $3,000. What is the overall capitalization rate?
   1. 1 percent
   2. 6 percent
   3. 12 percent
   4. 20 percent

Solution:

9. A small office building valued at $300,000 earned a net operating income of $52,000 annually. What is the direct capitalization rate?
   1. 3 percent
   2. 5.2 percent
   3. 17.3 percent
   4. 20 percent

Solution:

10. Which of the following estimates would result in a direct capitalization rate of 20 percent?
    1. Potential gross income $100,000; value $500,000
    2. Effective gross income $100,000; value $500,000
    3. Net operating income $100,000; value $500,000
    4. Cash flow $100,000; value $500,000

Solution:

11. A building with an annual net operating income of $8,000 is valued at $80,000. Estimate the value of the building if the capitalization rate is increased by one percentage point?
    1. $53,300
    2. $72,700
    3. $80,000
    4. $80,900

Solution:

12. Analysis of recent comparable sold properties indicates a gross rent multiplier around 6.75. You know that the subject property's gross rental income is $68,000 annually. What is the approximate value of the property?
    1. $459,000
    2. $10,074
    3. $38,250
    4. $750,000

Solution:

Questions 13 and 14 are based on the following information.

An office building recently sold for $2,000,000. Given the following information:

13. What is the overall rate of return for the property?
    1. 8.3 percent
    2. 9 percent
    3. 10 percent
    4. 10.12 percent

Solution:

14. What is the indicated gross income multiplier?
    1. 4
    2. 5
    3. 7.5
    4. 10.12

Solution:

15. A commercial office building with a sale price of $1,000,000 has a gross rent multiplier of 10. What is gross potential income of the property?
    1. $100,000
    2. $10,000,000
    3. $8,333
    4. $120,000,000

Solution: