Real Estate Investing Property Valuation Techniques 4 β Questions and Answers
Question 1: What is 'functional obsolescence' in real estate valuation?
- Value loss from deferred maintenance
- Value loss from outdated design, layout, or features within the property (Correct answer)
- Value loss from external economic forces
- Depreciation calculated over a 27.5-year schedule
Correct answer: Value loss from outdated design, layout, or features within the property
Functional obsolescence is caused by flaws or outdated features within the property itself, such as a poor floor plan or outdated kitchen.
Question 2: An investor uses a 10% discount rate to evaluate a property. If the required rate rises to 12%, how does the present value of future cash flows change?
- It increases
- It decreases (Correct answer)
- It stays the same
- It doubles
Correct answer: It decreases
A higher discount rate reduces the present value of future cash flows because future dollars are worth less in today's terms.
Question 3: In the cost approach, what does 'reproduction cost' mean?
- The cost to build a functionally equivalent substitute building using modern materials
- The cost to rebuild the exact same structure with identical materials and methods (Correct answer)
- The depreciated value of the building
- The insured replacement value set by the lender
Correct answer: The cost to rebuild the exact same structure with identical materials and methods
Reproduction cost is the cost to construct an exact replica using the same materials, design, and quality as the original structure.
Question 4: What does a cap rate compression indicate about market conditions?
- Rising interest rates are pushing property values down
- Investor demand is strong, driving prices up relative to income (Correct answer)
- NOI is declining while rents stay flat
- Vacancy rates are increasing in the submarket
Correct answer: Investor demand is strong, driving prices up relative to income
Cap rate compression (falling cap rates) signals strong buyer demand, which pushes prices up faster than income, reducing yield.
Question 5: Which type of comparable sale adjustment is NOT typically applied in the sales comparison approach?
- Location adjustment
- Financing terms adjustment
- Appraiser's personal preference adjustment (Correct answer)
- Time/market conditions adjustment
Correct answer: Appraiser's personal preference adjustment
Adjustments must be market-derived and objective; personal preference has no role in a credible appraisal.
Question 6: What is the 'band of investment' technique used to derive?
- Gross rent multiplier for multi-family properties
- An overall capitalization rate blending mortgage and equity return requirements (Correct answer)
- The effective tax rate on investment property
- Depreciation schedule for cost approach
Correct answer: An overall capitalization rate blending mortgage and equity return requirements
Band of investment calculates a blended cap rate by weighting the lender's mortgage constant and the equity investor's required return by their respective shares of value.
Question 7: Which scenario best illustrates 'paired sales analysis'?
- Comparing two properties in different cities to assess market trends
- Isolating a single feature's value contribution by finding two sales identical except for that feature (Correct answer)
- Averaging two appraisal values to determine market value
- Using two comparable sales to bracket the subject's value
Correct answer: Isolating a single feature's value contribution by finding two sales identical except for that feature
Paired sales analysis identifies the value of a specific feature by finding two otherwise identical sales that differ only in that feature.
Real Estate Investing Property Valuation Techniques 4
What is 'functional obsolescence' in real estate valuation?