CAE Income Approach to Value 2 — Questions and Answers
Question 1: The band of investment method derives the overall capitalization rate using:
- Only the equity return requirements of typical investors
- A weighted average of mortgage and equity components (Correct answer)
- Comparable sales data extracted from the open market
- Government bond yields adjusted for investment risk
Correct answer: A weighted average of mortgage and equity components
The band of investment method calculates a capitalization rate by weighting the mortgage constant and the equity dividend rate by their respective shares of total value.
Question 2: Market extraction (abstraction) derives an overall capitalization rate by:
- Dividing the NOI of comparable sales by their sale prices (Correct answer)
- Adding the mortgage constant to the equity dividend rate
- Analyzing national real estate investment survey data
- Applying a debt coverage ratio to the loan constant
Correct answer: Dividing the NOI of comparable sales by their sale prices
Market extraction divides the net operating income of each comparable sale by its sale price to produce an indicated capitalization rate from actual market evidence.
Question 3: A property generates an NOI of $75,000 and recently sold for $937,500. What is the extracted overall capitalization rate?
- 7.0%
- 8.0% (Correct answer)
- 9.0%
- 10.0%
Correct answer: 8.0%
$75,000 ÷ $937,500 = 0.08, or 8.0%, which is the market-extracted overall capitalization rate.
Question 4: Yield capitalization differs from direct capitalization primarily in that it:
- Uses gross income rather than net operating income
- Only applies to properties encumbered by long-term leases
- Incorporates anticipated future changes in income and value over time (Correct answer)
- Requires the assessor to identify comparable sales data
Correct answer: Incorporates anticipated future changes in income and value over time
Yield capitalization (DCF) explicitly models year-by-year income projections and a reversion, capturing anticipated changes that direct capitalization cannot reflect.
Question 5: The debt coverage ratio (DCR) method for deriving a capitalization rate requires knowing the:
- Loan-to-value ratio, mortgage constant, and required DCR (Correct answer)
- Equity yield rate and projected appreciation rate
- Gross rent multiplier and effective gross income
- Terminal cap rate and projected holding period
Correct answer: Loan-to-value ratio, mortgage constant, and required DCR
The DCR method formula is R = DCR × mortgage constant × loan-to-value ratio, requiring all three of those inputs.
Question 6: An assessor uses a 7.5% cap rate to value a property with a NOI of $90,000. The indicated value is approximately:
- $675,000
- $1,200,000 (Correct answer)
- $900,000
- $6,750,000
Correct answer: $1,200,000
$90,000 ÷ 0.075 = $1,200,000, which is the value indicated by direct capitalization.
Question 7: The effective gross income multiplier (EGIM) is calculated by dividing:
- EGI by NOI
- Sales price by EGI (Correct answer)
- NOI by the capitalization rate
- EGI by the sales price
Correct answer: Sales price by EGI
EGIM = Sale Price ÷ Effective Gross Income, producing a multiplier that can be applied to a subject property's EGI to estimate value.
CAE Income Approach to Value 2
The band of investment method derives the overall capitalization rate using: