California Real Estate Practice Exam

The income approach to appraisal requires the selection of an accurate capitalization rate because:

1. a property, which has a reliable tenant, would justify a higher capitalization rate than one with a tenant who has a poor financial background

2. a provision for return on the investment is a limitation on the calculation of a capitalization rate

3. the appraised value of property increases if the capitalization rate is decreased

4. the appraised value of property increases if the capitalization rate is increased

The correct answer is: a property, which has a reliable tenant, would justify a higher capitalization rate than one with a tenant who has a poor financial background

The income approach to appraisal is predicated on the ability of a property to generate income, which is assessed through the capitalization rate. An accurate capitalization rate reflects the expected rate of return on an investment and is crucial in determining the value of an income-producing property. Choosing the correct capitalization rate is essential because it influences how investors perceive the risk associated with the property. A property with a reliable tenant is viewed as less risky, potentially justifying a higher capitalization rate. Conversely, a property with a tenant that has a poor financial background poses a greater risk, which could lower the capitalization rate. This relationship highlights the importance of the tenant's reliability and financial strength in influencing the expected returns of the investment, ultimately affecting the appraised value of the property. The other options do not accurately capture the purpose or effect of selecting an accurate capitalization rate within the income approach. For instance, provisions for return on investment do define limits, but they do not directly relate to the necessity of selecting an accurate capitalization rate. Additionally, while it is true that the appraised value of a property increases if the capitalization rate is decreased (which aligns with market expectations of return), the choice does not accurately reflect on how tenant reliability specifically influences capitalization rate selection.