Real Estate Investing Real Estate Valuation Methods 3 β Questions and Answers
Question 1: In a discounted cash flow (DCF) analysis, what does the terminal value represent?
- The property's original purchase price
- The estimated resale value at the end of the holding period (Correct answer)
- The total rental income over the holding period
- The accumulated depreciation of the asset
Correct answer: The estimated resale value at the end of the holding period
Terminal value (reversion) is the projected sale price at the end of the investment horizon, typically estimated by capitalizing the final year's NOI.
Question 2: An office building has an NOI of $200,000. Using a 8% overall cap rate, what is the indicated value?
- $1,600,000
- $2,000,000
- $2,500,000 (Correct answer)
- $3,200,000
Correct answer: $2,500,000
Value = NOI Γ· Cap Rate = $200,000 Γ· 0.08 = $2,500,000.
Question 3: Which type of depreciation in the cost approach CANNOT be cured by the property owner?
- Physical deterioration β curable
- Functional obsolescence β curable
- External obsolescence (Correct answer)
- Deferred maintenance
Correct answer: External obsolescence
External (economic) obsolescence stems from forces outside the property, such as a nearby highway or declining neighborhood, and cannot be remedied by the owner.
Question 4: A property's effective gross income (EGI) is $120,000 and its operating expense ratio is 40%. What is the NOI?
- $48,000
- $72,000 (Correct answer)
- $80,000
- $96,000
Correct answer: $72,000
NOI = EGI Γ (1 β OER) = $120,000 Γ 0.60 = $72,000.
Question 5: Which adjustment in the sales comparison approach accounts for the fact that market conditions have improved since a comparable sale occurred six months ago?
- Location adjustment
- Market conditions (time) adjustment (Correct answer)
- Physical characteristics adjustment
- Financing concessions adjustment
Correct answer: Market conditions (time) adjustment
A market conditions adjustment (time adjustment) corrects for appreciation or depreciation that occurred between the comp's sale date and the appraisal date.
Question 6: What is the primary weakness of the Gross Rent Multiplier (GRM) as a valuation tool?
- It requires complex discounting calculations
- It ignores vacancies, expenses, and operating costs (Correct answer)
- It can only be used for commercial properties
- It requires a minimum of 10 comparable sales
Correct answer: It ignores vacancies, expenses, and operating costs
GRM uses gross rents only and does not account for vacancy, operating expenses, or property condition differences.
Question 7: A land plot costs $100,000 and a new building costs $400,000 to construct. The building has 20% accrued depreciation. What is the property's value under the cost approach?
- $380,000
- $400,000
- $420,000 (Correct answer)
- $500,000
Correct answer: $420,000
Value = Land ($100,000) + Depreciated Building ($400,000 Γ 0.80 = $320,000) = $420,000.
Real Estate Investing Real Estate Valuation Methods 3
In a discounted cash flow (DCF) analysis, what does the terminal value represent?