Lesson 5

Question 1

Capitalization

Answer 1

Process of converting a future stream of income flows into a single present value

Process of converting income from a property into an expression of capital value

Mathematical relationship between income and capital value

Question 2

Derivation of the Overall Capitalization Rate

Answer 2

Market analysis, summation method, weighted average method

Question 3

Techniques used in capitalization process: direct methods

Answer 3

Gross Income Multiplier, Equity Capitalization Rate, Mortgage Capitalization Rate, Overall Capitalization Rate
Do not differentiate between return on and return of capital

Question 4

Techniques used in capitalization process: annuity methods

Answer 4

Inwood using a factor, provides for return on and return of capital
Hoskold method, provides for return on capital at appropriate discount rate and return of capital using sinking fund factor
May be grouped into three main categories: variable, level, and increasing or decreasing annuities

Question 5

Techniques used in capitalization process: yield methods

Answer 5

Interest rate, Internal Rate of Return, Equity Yield Rate

Question 6

Direct capitalization vs yield method

Answer 6

Direct Capitalization is based on 1 year’s income, while yield method is based on a discounting process of future benefits over a finite investment period

Question 7

Gross Income Multiplier (GIM)

Answer 7

Sale Price / EGI

Question 8

Adjusted GIM

Answer 8

NOI ratio of subject / NOI ratio of comparable x comparable unadjusted GIM

Accounts for variations in profitability between different properties

Question 9

NOI Ratio

Answer 9

NOI / EGI. Sum of NOI ratio + expense ratio = 1

Question 10

Mortgage Capitalization Rate (Mortgage Constant)

Answer 10

Annual debt service / principal amount of mortgage

Expresses the relationship between the annual debt service and the principal amount of the mortgage at the date of sale. Percentage representing the portion of the loan amount that must be paid each year to repay the principal and interest owing on a loan. The annual payment that is required to repay the principal and interest on a loan of $1 within the amortization period.

Question 11

Equity Capitalization Rate

Answer 11

NOI - annual debt service / sale price - mortgage (cash flow / equity)

Ratio between forecasted before-tax cash flow and equity capital of purchase price.

Question 12

Derivation of overall capitalization rate: market-derived capitalization rate

Answer 12

To analyze several recent sales of similar properties to determine the overall capitalization rate implicit in the transactions

Question 13

Derivation of overall capitalization rate: summation method

Answer 13

Overall capitalization rate is built up through a rough decomposition of the elements of a discount rate. The analyst starts with the expected rate of return on a risk-free asset, then adds some risk premium to account for additional risks borne the subject property such as illiquidity, high transaction costs, cyclicity, locational constraints, and quality of management

Question 14

Derivation of overall capitalization rate: weighted average approach

Answer 14

Using a weighted average of the costs of borrowed capital and the cost of equity capital to determine the overall capitalization rate

Question 15

Equity Dividend Rate

Answer 15

The annual before-tax return on equity. In other words, the before-tax cash flows divided by the equity (BTCF/E).

Question 16

Overall Capitalization Rate (OCR)

Answer 16

OCR = NOI ÷ Value

Value = NOI ÷ OCR

NOI = Value x OCR

Question 17

Valuation of income-producing properties

Answer 17

Most commonly appraised using income-based valuation techniques. Market value estimate represents present value of expected future net benefits. Primarily impacted by principles of anticipation, change, supply and demand. Main problems facing appraiser are how to estimate income stream and how to discount these to present day.

Question 18

Fee Simple Interest

Answer 18

Most complete interest in real estate where the title is only encumbered by the four powers of government: taxation, land-use controls (police power), eminent domain, and escheat (reversion of title to government when an owner dies intestate).

Question 19

Leased Fee Estate

Answer 19

Ownership interest held by the lessor (landlord), which includes the right to receive the rent specified in the lease, plus the reversionary right when the lease expires

Question 20

Leasehold Estate

Answer 20

Right held by the lessee to use and occupy real estate for a stated term and under the conditions specified in the lease. Leasehold estate is the complement of the leased fee estate in that the value of the fee simple interest in the property would consist of the sum of the value of the leased fee interest plus the value of the leasehold interest.

Question 21

Value of leasehold estate

Answer 21

Difference in the present value between market rent and contract (i.e. excess rent, assuming market rent exceeds contract rent) for the remainder of the term, including the value of all rent incentives provided by the landlord

Question 22

Value of subleasehold or sublessee’s interest

Answer 22

Present value of the difference between market rent and contract rent for the unexpired term of the sublease

Question 23

What creates leasehold value

Answer 23

1. Change in market conditions

2. Capital investment by the lesee

Question 24

Net Effective Rent

Answer 24

Actual cash inflow resulting from a lease agreement