Chapter 16 Section 5

Question 1

direct capitalization

Answer 1

-a mathematical process in which future income is converted into present value
-7 steps in the direct capitalization approach:
-forecast the potential gross income
-estimate the vacancy and collection losses
-calculate the effective gross income
-estimate the operating expenses
-calculate the net operating income
-select an overall capitalization rate
-estimate the subject property value

Question 2

step 1: forecast the potential gross income

Answer 2

-PGI is the total annual income for the coming year
-two types of gross income
-contract rent
-market rent

Question 3

contract rent

Answer 3

-the amount that is specified in a lease
-it is used if the existing tenants have excellent credit and long term leases

Question 4

market rent

Answer 4

-the rent amount that is estimated for vacant or owner-occupied space and space occupied by tenants with short-term leases or those who have questionable credit

Question 5

step 2: vacancy and collection losses (V&C)

Answer 5

-this represents income that the owner will not receive
-the amount of vacancy and collection losses is estimated from the history of the subject property and competitive properties in the same market

Question 6

step 3: Subtract the V&C from the PGI

Answer 6

-the remaining income is called the effective gross income (EGI)
-if there is any other income form miscellaneous sources such as carport rentals, vending machines, and so on, add this amount after the V&C are subtracted
-this is the actual amount the owner can expect to receive from the operation of the property for one year into the future

Question 7

step 4: estimate operating expenses

Answer 7

-three types of operating expenses:
-fixed expenses
-variable expenses
-reserves for replacements

Question 8

fixed expenses

Answer 8

-do not change with occupancy levels
-property tax and hazard insurance

Question 9

variable expenses

Answer 9

-changes with occupancy levels
-utility, janitorial, management fees

Question 10

reserves for replacements

Answer 10

-funds that are set aside annually to replace short lived items

Question 11

step 5: NOI

Answer 11

-subtract all three types of operating expenses from the EGI to calculate the net operating income

Question 12

step 6: Cap rate

Answer 12

-select an overall capitalization rate
-the overall cap rate is a rate that is adequate to provide the investor with a return on the investment, and a return of the investment over the ownership period

Question 13

step 7: V=I/R

Answer 13

-estimate the value of the subject property by dividing the NOI by the overall capitalization rate
-V (value) = (net operating income) I/(capitalization rate) R

Question 14

gross multiplier technique

Answer 14

-uses gross rent or income instead of net operating income to estimate the value of 1-4 family rental properties

Question 15

gross rent multiplier

Answer 15

-applied for monthly rental properties
-comparable sales price/gross monthly rent

Question 16

gross income multiplier

Answer 16

-applied for properties with annual gross rental income
-comparable sales price/annual gross rental income