SAEE SAEE Income Approach and Capitalization 2 — Questions and Answers
Question 1: What is Effective Gross Income (EGI)?
- Potential gross income minus vacancy and collection loss (Correct answer)
- Potential gross income minus all operating expenses
- NOI plus capital reserves
- Gross income after debt service
Correct answer: Potential gross income minus vacancy and collection loss
EGI equals potential gross income (PGI) minus an allowance for vacancy and collection losses.
Question 2: In income property appraisal, what are capital reserves (replacement reserves)?
- Annual allowances set aside to replace short-lived building components (Correct answer)
- Emergency funds held by the property owner
- Equity buildup from mortgage amortization
- Funds reserved for property tax payments
Correct answer: Annual allowances set aside to replace short-lived building components
Capital reserves are annual allowances for replacing short-lived items like roofing, HVAC, and appliances to avoid large one-time expense distortions.
Question 3: What does a higher overall capitalization rate generally indicate about a property?
- Higher perceived investment risk (Correct answer)
- Lower perceived investment risk
- Stronger income growth expectations
- Better property location
Correct answer: Higher perceived investment risk
A higher cap rate typically indicates greater perceived risk or lower growth expectations, resulting in a lower property value for the same income level.
Question 4: What is the band-of-investment method used for?
- Developing an overall capitalization rate from mortgage and equity components (Correct answer)
- Estimating income from mixed-use properties
- Determining land-to-building value ratios
- Calculating effective gross income from comparable rentals
Correct answer: Developing an overall capitalization rate from mortgage and equity components
The band-of-investment method derives the overall cap rate by weighting mortgage constant and equity dividend rate by their respective loan-to-value ratios.
Question 5: In a Discounted Cash Flow analysis, what is the terminal (reversion) value?
- The estimated proceeds from property sale at the end of the holding period (Correct answer)
- The present value of all future income streams
- The property's depreciated book value at sale
- The original purchase price adjusted for inflation
Correct answer: The estimated proceeds from property sale at the end of the holding period
The terminal/reversion value is the estimated net proceeds from selling the property at the end of the projection period, typically estimated by capitalizing the following year's NOI.
Question 6: What is vacancy and collection loss in income property analysis?
- An allowance for lost income due to unleased space and uncollected rent (Correct answer)
- The cost of repairs from tenant damage
- Legal expenses from evictions
- Property management fees
Correct answer: An allowance for lost income due to unleased space and uncollected rent
Vacancy and collection loss represents the estimated income reduction due to unoccupied units and tenants who fail to pay rent.
SAEE SAEE Income Approach and Capitalization 2
What is Effective Gross Income (EGI)?