CGA Income Approach 3 — Questions and Answers
Question 1: A property has contract rent of $1,500/month but market rent is $1,800/month. The difference represents what concept?
- Bonus value accruing to the lessee (Correct answer)
- Excess rent accruing to the lessor
- Market value premium
- Effective gross income shortfall
Correct answer: Bonus value accruing to the lessee
When contract rent is below market rent, the tenant enjoys a bonus value — the economic benefit of the below-market lease.
Question 2: In yield capitalization, the discount rate applied to future cash flows is best described as which of the following?
- The investor's required rate of return on equity (Correct answer)
- The overall capitalization rate
- The risk-free Treasury rate alone
- The mortgage interest rate
Correct answer: The investor's required rate of return on equity
The discount rate in yield capitalization reflects the total return (yield) an equity investor requires given the risk of the investment.
Question 3: Which reserve expense category accounts for the periodic replacement of short-lived building components such as HVAC systems and roofs?
- Reserves for replacement (Correct answer)
- Operating reserves
- Structural reserves
- Capital improvement allowance
Correct answer: Reserves for replacement
Reserves for replacement (replacement reserves) are annual set-asides to fund eventual replacement of capital items with limited useful lives.
Question 4: The Ellwood mortgage-equity technique is primarily used to derive which analytical tool?
- An overall capitalization rate that reflects financing assumptions (Correct answer)
- A gross income multiplier
- A net income ratio
- A terminal cap rate
Correct answer: An overall capitalization rate that reflects financing assumptions
The Ellwood technique calculates an overall cap rate by combining mortgage terms, equity yield rate, and expected property value change.
Question 5: An office building has an effective gross income of $500,000 and an operating expense ratio of 40%. What is the net operating income?
- $300,000 (Correct answer)
- $200,000
- $500,000
- $700,000
Correct answer: $300,000
NOI = EGI × (1 − OER) = $500,000 × 0.60 = $300,000.
Question 6: Which income approach technique is most appropriate when future income streams are expected to be irregular or variable?
- Discounted cash flow analysis (Correct answer)
- Direct capitalization
- Gross rent multiplier method
- Land residual technique
Correct answer: Discounted cash flow analysis
DCF analysis explicitly models each period's cash flow and discounts them individually, making it ideal for irregular or changing income patterns.
Question 7: Under the income approach, 'reconstructed operating statements' are prepared primarily to accomplish what?
- Normalize income and expenses to reflect market-level, stabilized conditions (Correct answer)
- Report income for tax filing purposes
- Satisfy mortgage lender underwriting requirements
- Track historical accounting profits
Correct answer: Normalize income and expenses to reflect market-level, stabilized conditions
Reconstructed statements convert owner-reported financials to market-based figures by removing non-recurring items and adjusting non-market expenses.
CGA Income Approach 3
A property has contract rent of $1,500/month but market rent is $1,800/month.
The difference represents what concept?