Real Estate Investing Investment Property Valuation 4 β Questions and Answers
Question 1: A property's potential gross income is $120,000. Vacancy and collection loss is 5% and operating expenses are $40,000. What is the NOI?
- $74,000 (Correct answer)
- $80,000
- $114,000
- $76,000
Correct answer: $74,000
EGI = $120,000 Γ 0.95 = $114,000; NOI = $114,000 β $40,000 = $74,000.
Question 2: What is the band-of-investment method used to estimate in property valuation?
- The overall capitalization rate (Correct answer)
- The loan-to-value ratio
- The property's replacement cost
- The gross rent multiplier
Correct answer: The overall capitalization rate
The band-of-investment method derives a cap rate by weighting mortgage and equity return requirements by their share of total investment.
Question 3: Which situation would most likely cause external obsolescence in a rental property's valuation?
- A new highway built adjacent to the property (Correct answer)
- A leaking roof that reduces rental appeal
- An outdated HVAC system
- Below-market lease rates on existing tenants
Correct answer: A new highway built adjacent to the property
External obsolescence is caused by factors outside the property, such as nearby highways, industrial development, or economic downturns.
Question 4: An investor values a property using a 7% cap rate but the seller used 5.5%. Why might they disagree?
- Different risk perceptions or required returns (Correct answer)
- Different property square footage estimates
- Different mortgage interest rates
- Different depreciation schedules
Correct answer: Different risk perceptions or required returns
Cap rates reflect investor risk tolerance and return expectations; a higher cap rate signals the buyer requires more return or perceives more risk.
Question 5: In the discounted cash flow (DCF) method, what is the terminal value?
- The estimated resale price at the end of the holding period (Correct answer)
- The total rental income over the holding period
- The sum of all annual NOIs
- The original purchase price adjusted for inflation
Correct answer: The estimated resale price at the end of the holding period
Terminal value (reversion) is the projected sale price at the end of the analysis period, often estimated by capitalizing the final year's NOI.
Question 6: Which of the following is NOT included in operating expenses when calculating NOI?
- Mortgage principal payments (Correct answer)
- Property insurance premiums
- Routine maintenance costs
- Property management fees
Correct answer: Mortgage principal payments
Mortgage principal (and interest) is a financing cost, not an operating expense; NOI is calculated before debt service.
Question 7: A commercial property sells for $2 million with an NOI of $160,000. A comparable sold last year at a 7.5% cap rate. Is this property over- or underpriced?
- Overpriced β implied cap rate of 8% exceeds market at 7.5%
- Underpriced β implied cap rate of 8% exceeds market at 7.5% (Correct answer)
- Fairly priced β both cap rates are within normal range
- Overpriced β the NOI is too low for the asking price
Correct answer: Underpriced β implied cap rate of 8% exceeds market at 7.5%
Implied cap rate = $160,000 Γ· $2,000,000 = 8%; since 8% > market rate of 7.5%, the property offers more income per dollar, meaning it may be underpriced relative to market.
Real Estate Investing Investment Property Valuation 4
A property's potential gross income is $120,000.
Vacancy and collection loss is 5% and operating expenses are $40,000.
What is the NOI?