CGA Property Evaluation & Analysis 3 — Questions and Answers
Question 1: The principle of substitution states that:
- A property's value is determined by the future benefits it produces
- A buyer will pay no more for a property than the cost of acquiring an equally desirable substitute (Correct answer)
- The value of a component depends on how much it adds to the whole
- Supply and demand interact to set market prices
Correct answer: A buyer will pay no more for a property than the cost of acquiring an equally desirable substitute
The principle of substitution holds that a rational buyer will not pay more for a property than the cost of obtaining an equally desirable alternative.
Question 2: In income capitalization, a lower capitalization rate applied to the same NOI results in:
- A lower indicated value
- A higher indicated value (Correct answer)
- No change in indicated value
- A higher effective gross income
Correct answer: A higher indicated value
Since value = NOI ÷ cap rate, a lower cap rate produces a higher indicated property value when NOI remains constant.
Question 3: Functional obsolescence caused by a deficiency that cannot be corrected is classified as:
- Curable physical deterioration
- Incurable functional obsolescence (Correct answer)
- External obsolescence
- Curable functional obsolescence
Correct answer: Incurable functional obsolescence
Incurable functional obsolescence exists when the cost to cure exceeds the value gain from curing, or when it is physically impossible to correct.
Question 4: What does the term 'arm's-length transaction' mean in the context of real property appraisal?
- A sale occurring between family members at a discounted price
- A sale in which both parties act prudently, knowledgeably, and without duress or special relationships (Correct answer)
- A transaction requiring a licensed real estate broker as intermediary
- A sale where the seller accepts less than market value due to financial hardship
Correct answer: A sale in which both parties act prudently, knowledgeably, and without duress or special relationships
An arm's-length transaction involves unrelated parties with equal bargaining power, both acting in their own best interests without compulsion.
Question 5: When using the income approach for a commercial property, vacancy and collection loss is deducted from:
- Net operating income
- Effective gross income
- Potential gross income (Correct answer)
- Net cash flow
Correct answer: Potential gross income
Vacancy and collection loss is subtracted from potential gross income to arrive at effective gross income, the first step in building to NOI.
Question 6: In the cost approach, entrepreneurial profit (also called entrepreneurial incentive) represents:
- The developer's profit already embedded in market sales prices
- The profit a developer expects to earn as compensation for risk and expertise in a development project (Correct answer)
- The appraiser's fee for preparing the cost estimate
- The markup added by a general contractor above hard costs
Correct answer: The profit a developer expects to earn as compensation for risk and expertise in a development project
Entrepreneurial profit is the amount a developer expects to earn above and beyond costs as compensation for risk, time, and management of a project.
Question 7: A gross rent multiplier (GRM) is most appropriately applied to:
- Large, complex commercial properties with detailed financial records
- Residential income properties where gross rent data is readily available (Correct answer)
- Properties valued using the cost approach only
- Land parcels with no existing improvements
Correct answer: Residential income properties where gross rent data is readily available
The GRM is a simplified income tool most appropriate for smaller residential income properties where gross rent comparables are plentiful.
CGA Property Evaluation & Analysis 3
The principle of substitution states that: