CAE Income Approach to Value 1 — Questions and Answers
Question 1: What does 'effective gross income' (EGI) represent in the income approach to property valuation?
- Potential gross income minus vacancy and collection losses (Correct answer)
- Net income after all operating expenses are deducted
- Income before any adjustments for market conditions
- Total rental income including all concessions and premiums
Correct answer: Potential gross income minus vacancy and collection losses
Effective gross income is derived by subtracting anticipated vacancy and collection losses from potential gross income.
Question 2: Which of the following costs is typically classified as a 'below-the-line' expense NOT included in calculating net operating income?
- Property management fees
- Real estate taxes
- Debt service (mortgage payments) (Correct answer)
- Insurance premiums
Correct answer: Debt service (mortgage payments)
Debt service (mortgage payments) is a financing cost that falls below the NOI line and is not an operating expense of the property itself.
Question 3: The direct capitalization formula states that value equals:
- NOI multiplied by the holding period
- NOI divided by the capitalization rate (Correct answer)
- EGI multiplied by the overall rate
- PGI divided by the vacancy rate
Correct answer: NOI divided by the capitalization rate
The direct capitalization formula is V = NOI ÷ R, where V is value, NOI is net operating income, and R is the overall capitalization rate.
Question 4: In the income approach, a 'stabilized' vacancy rate assumes:
- Zero vacancy in the best performing year
- The actual current vacancy of the subject property
- A long-term typical market vacancy under normal conditions (Correct answer)
- The highest vacancy rate observed in the market area
Correct answer: A long-term typical market vacancy under normal conditions
A stabilized vacancy rate reflects long-term typical market conditions rather than the current occupancy, ensuring the valuation is not distorted by temporary fluctuations.
Question 5: Which category of expenses BEST fits 'property management fees' in income approach analysis?
- Fixed expenses
- Variable expenses (Correct answer)
- Reserves for replacement
- Capital expenditures
Correct answer: Variable expenses
Management fees are variable expenses because they typically fluctuate with the level of collected income (e.g., a percentage of EGI).
Question 6: The gross rent multiplier (GRM) is MOST useful for valuing which type of property?
- Large regional shopping centers
- Small residential income properties (Correct answer)
- Special purpose industrial facilities
- Agricultural land and timberland
Correct answer: Small residential income properties
The GRM is a simplified income multiplier best suited for small residential income properties where detailed expense data may be unavailable.
Question 7: When contract rent is BELOW market rent, the tenant's interest is known as:
- Overage rent interest
- Bonus rent position
- Leasehold estate value (Correct answer)
- Excess rent entitlement
Correct answer: Leasehold estate value
When a tenant pays below-market contract rent, the benefit of that favorable lease creates a leasehold estate value attributable to the tenant.
CAE Income Approach to Value 1
What does 'effective gross income' (EGI) represent in the income approach to property valuation?