PSI Real Estate Appraisal 2 — Questions and Answers
Question 1: In the income approach, net operating income (NOI) is calculated as:
- Gross scheduled income minus vacancy and collection loss only
- Effective gross income minus operating expenses (excluding debt service) (Correct answer)
- Gross income minus mortgage payments and taxes
- Potential gross income minus all expenses including depreciation
Correct answer: Effective gross income minus operating expenses (excluding debt service)
NOI equals effective gross income (potential income adjusted for vacancy/collection loss) minus all operating expenses, but does NOT include mortgage debt service or income taxes.
Question 2: Direct capitalization converts a single year's income into a value estimate by:
- Multiplying NOI by the projection period in years
- Dividing NOI by the overall capitalization rate (Correct answer)
- Adding NOI to the estimated resale proceeds
- Subtracting the vacancy rate from gross scheduled income
Correct answer: Dividing NOI by the overall capitalization rate
In direct capitalization, Value = NOI ÷ Cap Rate; dividing the stabilized annual NOI by the market-derived overall capitalization rate yields the indicated value.
Question 3: The cost approach is generally most reliable when appraising:
- Older income-producing properties in declining markets
- Properties with little or no depreciation, such as newly constructed buildings (Correct answer)
- Vacant land with multiple potential uses
- Single-family homes in active resale markets
Correct answer: Properties with little or no depreciation, such as newly constructed buildings
The cost approach is most reliable for new or nearly new properties where depreciation is minimal and construction costs are well-documented.
Question 4: Reproduction cost in the cost approach refers to:
- The cost to construct an exact replica of the existing structure using current materials and techniques (Correct answer)
- The cost to build a structure of equal utility using modern materials and design standards
- The depreciated value of the building after deducting all forms of obsolescence
- The insured replacement value established by the property owner's insurer
Correct answer: The cost to construct an exact replica of the existing structure using current materials and techniques
Reproduction cost is the cost to build an exact duplicate of the subject structure using the same or very similar materials and construction methods at current prices.
Question 5: Functional obsolescence in a residential property is best illustrated by:
- Roof damage caused by a recent hailstorm
- A four-bedroom home with only one bathroom (Correct answer)
- Declining property values due to neighborhood blight
- Foundation settling caused by soil movement
Correct answer: A four-bedroom home with only one bathroom
Functional obsolescence results from a deficiency or superadequacy in the design or layout of the improvement; a four-bedroom home with one bathroom represents an inadequate feature relative to market expectations.
Question 6: Effective gross income (EGI) is defined as:
- Potential gross income plus miscellaneous income
- Potential gross income minus vacancy and collection loss, plus other income (Correct answer)
- Net operating income before operating expenses
- Gross rental income multiplied by the gross rent multiplier
Correct answer: Potential gross income minus vacancy and collection loss, plus other income
EGI equals potential gross income minus an allowance for vacancy and collection loss, plus any miscellaneous other income such as parking fees or laundry income.
Question 7: The capitalization rate (cap rate) reflects:
- The ratio of annual mortgage payments to purchase price
- The required rate of return on an investment property relative to its value (Correct answer)
- The percentage of gross income retained after vacancy losses
- The annual appreciation rate expected for the property
Correct answer: The required rate of return on an investment property relative to its value
The overall capitalization rate represents the ratio of NOI to property value (Cap Rate = NOI / Value) and reflects the market's required rate of return for that property type and risk level.
PSI Real Estate Appraisal 2
In the income approach, net operating income (NOI) is calculated as: