CHI Market Analysis & Valuation 3 — Questions and Answers
Question 1: What is 'capitalization rate' (cap rate) used for in real estate valuation?
- Calculating property tax liability
- Converting a property's net operating income into an estimated value (Correct answer)
- Measuring how quickly a property appreciates
- Determining the loan-to-value ratio for financing
Correct answer: Converting a property's net operating income into an estimated value
The cap rate divides a property's net operating income by its value, helping investors assess return potential and compare income-producing properties.
Question 2: Which type of depreciation in real estate valuation is considered incurable?
- Deferred maintenance on exterior paint
- Functional obsolescence due to poor floor plan that cannot be economically corrected (Correct answer)
- Worn flooring that can be replaced at reasonable cost
- A leaking roof that requires immediate repair
Correct answer: Functional obsolescence due to poor floor plan that cannot be economically corrected
Incurable depreciation occurs when the cost to fix a deficiency exceeds the value it would add, making correction economically impractical.
Question 3: In a Comparative Market Analysis (CMA), what is the primary purpose of making 'adjustments' to comparable sales?
- To account for the real estate agent's commission
- To align the comparable's price with the subject property's features and condition (Correct answer)
- To inflate the estimated value to attract higher offers
- To correct errors in the public tax records
Correct answer: To align the comparable's price with the subject property's features and condition
Adjustments compensate for differences between comparables and the subject so the resulting values reflect what the comps would have sold for if identical to the subject.
Question 4: How does economic obsolescence differ from physical deterioration in a property valuation context?
- Physical deterioration is caused by external forces; economic obsolescence comes from within the property
- Economic obsolescence is a loss in value from external market forces; physical deterioration results from wear and age (Correct answer)
- They are different names for the same concept in modern appraisal practice
- Physical deterioration applies only to commercial properties
Correct answer: Economic obsolescence is a loss in value from external market forces; physical deterioration results from wear and age
Physical deterioration is wear from use and age within the property, while economic obsolescence is a value loss caused by factors external to the property.
Question 5: A home inspector identifies that a neighborhood has experienced significant commercial encroachment over the past five years. Which valuation concept does this most directly affect?
- Physical depreciation of structural components
- Functional obsolescence of interior design
- External (economic) obsolescence of residential properties (Correct answer)
- Cost approach land valuation
Correct answer: External (economic) obsolescence of residential properties
Commercial encroachment into a residential neighborhood is a classic example of external obsolescence, reducing the desirability and value of nearby homes.
Question 6: What does 'absorption rate' measure in a real estate market analysis?
- The percentage of a home's square footage used for living space
- How quickly available homes are sold in a given market over a specific time period (Correct answer)
- The rate at which moisture enters a building's foundation
- The ratio of asking price to final sale price
Correct answer: How quickly available homes are sold in a given market over a specific time period
Absorption rate calculates how fast homes are sold in a market, indicating whether it favors buyers or sellers and how long current inventory will last.
Question 7: Which principle of value states that the value of an inferior property is enhanced by its proximity to superior properties?
- Principle of substitution
- Principle of progression (Correct answer)
- Principle of regression
- Principle of contribution
Correct answer: Principle of progression
The principle of progression holds that a lower-value property benefits from being located near higher-value properties, pulling its value upward.
CHI Market Analysis & Valuation 3
What is 'capitalization rate' (cap rate) used for in real estate valuation?