Income (Capitalization) Approach +13California · Real Estate · English

The Income Approach values present worth of future benefits (income stream) and is important for income-producing property. Capitalization converts future income into present worth. Two methods: Direct capitalization (single annual period) and Yield capitalization (multi-year). Based on the principle of anticipation.

• ✓Income Approach is based on the principle of anticipation
• ✓Capitalization converts future income into present worth
• ✓Direct capitalization uses a single annual period; yield uses multi-year
• ✓Appraiser uses net income a fully informed person with competent management can expect

The Overall Rate formula: Net Annual Income ÷ Overall Rate = Value (I ÷ R = V). If two factors are known, the third can be found: I = R × V, and R = I ÷ V. A 1% rate variation makes a substantial difference; lower rate = higher value.

• ✓I ÷ R = V (Income divided by Rate equals Value)
• ✓I = R × V and R = I ÷ V
• ✓A variation of only 1% substantially changes capitalized value
• ✓The lower the rate, the greater the valuation and assumed security

Start with Potential Gross Income, deduct vacancy/collection loss to get Effective Gross Income, then deduct expenses to get Net Operating Income (NOI). Expenses are fixed (taxes, insurance), variable (utilities, management), and reserves for replacements. Mortgage payments and book depreciation are NOT allowable expenses.

• ✓Potential Gross − Vacancy/Collection = Effective Gross Income
• ✓Effective Gross − Operating Expenses = Net Operating Income
• ✓Expense types: fixed, variable, and reserves for replacements
• ✓Principal/interest payments and income-tax depreciation must be disregarded by the appraiser

The Overall Rate provides return OF capital plus return ON investment, and is derived from analysis of comparable sales. Greater risk means a higher rate. The rate is dependent on the return investors demand.

• ✓Overall Rate provides return OF capital plus return ON investment
• ✓Greater risk of losing investment = higher rate
• ✓Preferred derivation is from comparable sales' net income to price relationship

Two reconciliations must be made monthly: bank account record with the bank statement, and bank account record with the separate beneficiary records. The latter is required by Regulation 2831.2.

• ✓Reconciliation of bank account record with separate beneficiary records is required by Regulation 2831.2
• ✓Reconciliation of bank account record with bank statement is good practice but not required by law
• ✓Must be performed monthly except in months with no trust account activity, and a record of each reconciliation must be maintained
• ✓The reconciliation record must identify account name/number, date, beneficiary/transaction identity, and liability to each

An unexplained overage is funds exceeding aggregate trust fund liability where the broker cannot determine ownership. These are trust funds and must be maintained separately.

• ✓Unexplained overages must be maintained in the trust account or a separate trust account and may not offset shortages
• ✓The broker must keep a separate record and subsidiary ledger including the date of recording and the date funds became an overage
• ✓Monthly reconciliation of overage funds is required per Regulation 2831.2

Proration adjusts interest, taxes, and insurance on a pro rata basis as of closing. Prepaid items of expense (e.g., three-year fire insurance) are credited to the seller for unused portions, usually done in escrow.

• ✓Proration adjusts items on a pro rata basis as of closing
• ✓Prepaid expenses are credited to the seller for unused portions
• ✓Usually done in escrow by the escrow holder at closing

A trust account is separate, apart, and physically segregated from the broker's own funds, in which the broker is required by law to deposit all funds collected for clients.

• ✓Must be separate and physically segregated from broker's funds
• ✓Broker must deposit all client funds by law

Recording places a document on file with the County Recorder for public notice, imparting constructive/legal notice. Claim priority is based on the time and date of recording, with the earliest recorded claim preferred.

• ✓Recording imparts constructive (legal) notice to the public
• ✓Recorder stamps time and date of filing
• ✓Priority generally goes to the earliest recorded claim

Reserves for mortgage loans are funds collected by the lender from the borrower as part of each monthly payment, allocated to pay property taxes and insurance when due. In CID subdivisions, reserves fund future common area maintenance.

• ✓Mortgage reserves pay property taxes and insurance when due
• ✓CID reserves fund future replacement and major common area maintenance

An offset statement is a statement by the owner of property or owner of a lien setting forth the present status of liens against the property.

• ✓Made by the property owner or lien holder
• ✓Sets forth the present status of liens

The Commissioner must investigate upon a verified written complaint, or may investigate on his own motion, and can suspend or revoke a license or deny an application. Investigations typically begin with a written statement from a wronged party. The Commissioner receives DOJ reports of subsequent arrests or convictions of licensees.

• ✓The Commissioner shall investigate upon a verified written complaint or may act on his own motion
• ✓The Commissioner may suspend, revoke, or deny a license
• ✓After licensing, the Commissioner receives DOJ reports of subsequent arrests or convictions

Formal hearings follow the Administrative Procedure Act. The Commissioner becomes the complainant and the licensee is the respondent. An administrative law judge from the Office of Administrative Hearings hears the case and issues a proposed decision, which the Commissioner may accept, reject, or reduce. After revocation, the person cannot apply for reinstatement for at least one year (or as specified, whichever is greater).

• ✓Formal hearings follow the Administrative Procedure Act with an administrative law judge
• ✓The Commissioner becomes the complainant; the licensee is the respondent
• ✓After revocation, no reinstatement application for at least one year (or period specified, whichever is greater)

Representatives investigate unlicensed or improper operators and subdividers. If a violation is found, an Order to Desist and Refrain is issued or the parties are prosecuted. The Commissioner may issue a bar order (up to three years) precluding individuals from real estate brokerage, lending, escrow, or title positions when in the public interest.

• ✓An Order to Desist and Refrain may be issued for violations by unlicensed or improper operators
• ✓A bar order may preclude individuals from specified real estate activities for up to three years
• ✓Bar Order recipients have the right to request an administrative hearing on the order's merits

The homestead exemption shields the home against certain creditors enforcing judgment liens. It does NOT protect against all forced sales—e.g., judgments recorded before the declaration, pre-existing encumbrances, or mechanics'/materialmen's liens. Voluntary encumbrances (mortgage/deed of trust) are unaffected by the declaration.

• ✓The homestead protects against certain judgment lien enforcements, up to the exemption amount
• ✓It does not protect against pre-recorded judgments, pre-existing encumbrances, or mechanics' liens
• ✓Voluntary encumbrances (mortgages/deeds of trust) are not affected by a homestead declaration

CCP Sections 704.710 et seq. contain two homestead protections. Article 4 protects qualifying homeowner debtors who have NOT filed a declaration. Article 5 concerns homeowners who record a homestead declaration. Both protect against certain judgment liens up to the exemption amount.

• ✓Article 4 = automatic residential exemption without a declaration
• ✓Article 5 = protection requiring a recorded homestead declaration
• ✓A separate 'Probate Homestead' also exists (Probate Code 60, 6520–6528)

The exemption depends on the debtor's status when the creditor's lien is recorded: $50,000 base; $75,000 for a family unit member with another member who owns no interest; and $150,000 for a person 65+, a disabled person unable to work, or a person 55+ with limited income in an involuntary sale. Combined spousal exemptions cannot exceed the applicable family-unit amount.

• ✓$50,000 base; $75,000 family unit; $150,000 for 65+, disabled, or qualifying 55+ low-income
• ✓Combined spousal exemptions cannot exceed the applicable $75,000 or $150,000 amount
• ✓The amount is based on the debtor's status when the creditor's lien is recorded

A declared homestead is created by recording a declaration in the county where the dwelling is located; the declaration must name the owner, describe the property, and state it is the principal dwelling where the owner/spouse resides on the recording date. It must be executed and acknowledged like a deed. A homestead cannot be declared after filing bankruptcy.

• ✓The declaration must state the property is the owner's/spouse's principal dwelling on the recording date
• ✓The declaration must be acknowledged in the manner of a conveyance and recorded to be effective
• ✓A homestead cannot be declared after filing a bankruptcy petition
• ✓A homestead declaration does not restrict the right to convey or encumber the property

On a levy against a homestead, the creditor must apply to the court within 20 days for an order to sell. The court sets a minimum bid covering liens, the exemption, and the enforcing lien; if no adequate bid is received, no sale occurs and the creditor must wait a year. Sale proceeds are exempt for 6 months if reinvested in a new homestead.

• ✓Creditor must apply to court within 20 days after levy for an order of sale
• ✓Property is not sold unless the minimum bid (covering prior liens, exemption, and enforcing lien) is met
• ✓Sale proceeds are exempt 6 months; reinvestment with a new declaration relates back to the prior recording date

The Federal Homestead Act of 1862 encouraged settlement by granting title to those establishing residence/improvements on federal land. It is unrelated to the California declared homestead. Homesteading on public lands was discontinued in 1976 (except Alaska) by the Federal Land Policy and Management Act.

• ✓Federal homesteading granted title to settlers of public land—unrelated to the CA declared homestead
• ✓Homesteading on public land was repealed in 1976 (except Alaska)

A licensed escrow holder/agent must keep accurate accounts and records subject to examination by the Commissioner of Corporations. The corporation must annually submit, at its own expense, an independent audit prepared by a Certified Public Accountant. Real estate brokers conducting sale escrows are subject to audit of their trust funds and examination of their accounts and records by the Real Estate Commissioner.

• ✓Licensed escrow agents must annually submit an independent CPA audit at their own expense
• ✓Escrow records are subject to examination by the Commissioner of Corporations
• ✓Brokers conducting escrows are subject to trust fund audit and examination by the Real Estate Commissioner

FCRA Section 609(g), added by the FACT Act, requires disclosure of an applicant's credit score whenever a credit score is used with an application secured by 1-4 unit residential real property, regardless of the credit decision outcome. It does not apply to loans secured by mobile homes. The disclosure must be delivered 'as soon as reasonably practicable' and include six items of information plus the required statutory notice.

• ✓Credit score disclosure is required when a score is used for a loan secured by 1-4 unit residential real property
• ✓Disclosure is required regardless of whether the application is approved, denied, withdrawn, or closed
• ✓The disclosure does not apply to loans secured by mobile homes
• ✓Up to four key factors adversely affecting the score must be disclosed

If an applicant believes there is a mistake in his/her credit report, they can contact the credit repository. Under FCRA, the repository must complete an investigation within 30 days, provide written notice of results within 5 days of completion, and provide a copy of the corrected report. The FTC enforces FCRA. The three California repositories are Experian, TransUnion, and Equifax.

• ✓A credit repository must complete a dispute investigation within 30 days
• ✓Written notice of investigation results must be provided within 5 days of completion
• ✓The FTC is responsible for enforcing FCRA

Disclosures must include the identity of the creditor and the MLO unique identifier, be in writing, clear and conspicuous, and in a form the borrower may keep. Electronic disclosures require E-Sign Act consumer consent (with certain exceptions). Payees like public officials, credit reporting agencies, appraisers, and insurance companies may be identified using generic terms.

• ✓Disclosures must identify the creditor and the loan originator (MLO) unique identifier
• ✓Electronic disclosures require E-Sign Act consumer consent, subject to certain exceptions
• ✓Disclosures must be in writing, clear and conspicuous, and in a keepable form
• ✓Certain payees may be identified using generic or general terms

For variable-rate loans secured by a principal dwelling with a term over one year, lenders must provide the Consumer Handbook on Adjustable Rate Mortgages and a loan program disclosure at application or before a non-refundable fee. Disclosures include how the rate/payment is determined, the index/margin, discount statements, frequency of changes, and either a historical example based on a $10,000 loan over 15 years or the maximum rate/payment.

• ✓Provide the Consumer Handbook on Adjustable Rate Mortgages and program disclosure at application or before a non-refundable fee
• ✓Historical example is based on a $10,000 loan amount reflecting the most recent 15 years of index values
• ✓Disclosures must state whether the rate, payment, or term can change and the index/margin used

Other required disclosures include the schedule of payments; demand feature (only if part of the legal obligation, not default conversions); total sale price in credit sales; prepayment penalties/rebates; late payment charges (only pre-maturity); security interest; insurance; certain security charges (filing fees and taxes); reference to contract terms; assumption policy; and required deposit (stating the APR does not reflect the deposit's effect).

• ✓Prepayment penalty disclosure is required, including a statement even if no penalty is charged
• ✓Late payment charge disclosure applies only to charges imposed before maturity
• ✓The security interest disclosure for purchased collateral may use a general identification
• ✓The rule of 78s rebate method no longer needs to be disclosed

The borrower is entitled to a written itemization of the amount financed, separated from other disclosures, which may be accomplished through the GFE. The itemization discloses proceeds distributed directly to the borrower, amounts credited to the borrower's account, and amounts paid to other persons on the borrower's behalf (identifying those persons).

• ✓The itemization of amount financed may be accomplished through the GFE
• ✓It must disclose proceeds to the borrower, amounts credited to the account, and amounts paid to others
• ✓Persons paid on the borrower's behalf must be identified

The adjusted tax basis is central to computing gain or loss. Basis differs based on how property was acquired: purchase, gift, or inheritance.

• ✓Purchased property basis = purchase price adjusted over time (e.g., depreciation)
• ✓Gift property basis = donor's cost (or lower market value at gift if claiming a loss)
• ✓Inherited property basis = fair market value at date of death (step-up)

Because of the complexity of real estate tax law, a broker who is not also a tax professional should not offer tax advice but should refer clients to qualified professionals.

• ✓Broker should never offer tax advice unless also an income tax investment counselor
• ✓Broker should urge clients to consult a real estate tax attorney, CPA, or other qualified person

Tax planning is key to analyzing real estate investment. Investors seek to shelter income, generate losses, obtain favorable capital gains treatment, or defer tax liability. The method of acquisition has important tax consequences at disposition.

• ✓Investors seek: shelter income, generate losses, favorable capital gains, or deferral of tax liability
• ✓Method of acquisition mostly affects tax consequences at sale/disposition, not acquisition
• ✓Individual ownership can later transfer property to a corporation tax-free

Title may be held via corporation or individually (community property, joint tenancy, tenancy in common). Each form has tax and probate implications, notably regarding step-up in basis.

• ✓Corporate ownership lets dealers segregate investment property from stock in trade
• ✓Joint tenancy simplifies death processing but cannot be controlled by will
• ✓The half not in the decedent's gross estate in joint tenancy does not receive a step-up in basis

A tentative map shows the proposed subdivision design and existing topography, prepared per local ordinance requirements including legal description, streets, lots, easements, and utilities.

• ✓Design must provide for future passive heating and cooling to the extent possible (not applicable to converted condominiums)
• ✓Contents include legal description, adjoining street widths/names, proposed use, street grades/widths, easements, lot layout, watercourses, water supply, sewage disposal method, and public areas
• ✓Many jurisdictions require the tentative map be based on a survey by a registered civil engineer, licensed land surveyor, or professional planner

After filing, multiple departments review the tentative map and report to planning; a public hearing follows. Approval requires conformance with general and specific plans.

• ✓Various departments (road, health, flood control, parks, school, surveyor) review and report on the map
• ✓Coastal Zone subdivisions require sending a copy to the California Coastal Commission
• ✓Approval requires conformance to general and specific plans, acceptable density, physical suitability, and health/environmental considerations
• ✓Reports may recommend approval, conditional approval, or disapproval

A subdivider has strict deadlines to appeal adverse tentative map actions, with the local jurisdiction subject to hearing and decision deadlines.

• ✓The subdivider has 10 days from adverse action to file an appeal
• ✓A hearing must be held within 30 days after the appeal is filed
• ✓The decision must be rendered within 10 days after the hearing
• ✓Failure to act timely deems the map approved insofar as it complies with the Map Act and local ordinance

A vesting tentative map (Government Code 66498.1) gives the subdivider rights to develop in substantial compliance with ordinances and standards in effect when approved.

• ✓A vesting tentative map grants rights to proceed under ordinances/standards in effect at approval
• ✓Development agreements (Government Code 65864 et seq.) are another way to secure development rights
• ✓Entering into a development agreement is a discretionary act

Goodwill of a business has monetary value protected by law and is defined as the expectation of continued public patronage. Factors in valuing goodwill include sales/profit history (weighted toward current figures), length of establishment at present location, location and growth potential, competitive situation, the business name reputation, the non-compete agreement, and customer traffic characteristics.

• ✓Goodwill is the expectation of continued public patronage and has legally protected monetary value
• ✓A location or license amounting to a monopoly can command a premium for goodwill
• ✓For a liquor license there may be a limit on the valuation of goodwill
• ✓Greater weight is given to the most current sales and profit figures

The organization is the National Association of Real Estate Brokers, Incorporated, currently incorporated under the laws of Michigan. Its purposes include uniting those in recognized branches of real estate, enabling more professional business, maintaining high conduct standards, formulating and enforcing a code of ethics, licensing use of the 'Realtist' term, and protecting the public against unethical practices.

• ✓NAREB is incorporated under the laws of the State of Michigan
• ✓NAREB purposes include enforcing a code of ethics and licensing the term 'Realtist'
• ✓'Realtist' designates a recognized certified NAREB member

Sections 10176 and 10177 are the foundation for most license suspensions/revocations. Section 10176 applies to a licensee acting as an agent in a real estate transaction, while parts of Section 10177 apply even when not acting as an agent. Section 10176 grounds include misrepresentation, false promise, continued misrepresentation, dual agency, and commingling.

• ✓Section 10176 generally requires the licensee to have been acting as an agent
• ✓Section 10176(a) covers misrepresentation, including failure to disclose material facts to a principal
• ✓Damage or injury need not be present to support a misrepresentation action under 10176(a)

Section 10176(d) covers failure to inform all principals that the licensee is acting as agent for more than one party. Section 10176(e) covers commingling — mixing a principal's funds with the broker's own money. Conversion (misappropriating and using a principal's funds) is a more serious offense.

• ✓Dual agency violation (10176(d)) is failure to inform all principals of representing multiple parties
• ✓Commingling (10176(e)) is mixing a principal's funds with the broker's own money
• ✓Conversion (misappropriating/using a principal's funds) is more serious than commingling

Section 10177 grounds include: obtaining a license by fraud (a), criminal conviction involving moral turpitude substantially related to licensee duties (b), false advertising (c), violations of other sections (d), misuse of trade name (e), conduct warranting denial/dishonesty (f), and negligence or incompetence (g).

• ✓Section 10177(a) covers procuring a license by fraud, misrepresentation, or deceit
• ✓Section 10177(b) covers criminal conviction involving moral turpitude related to licensee duties
• ✓Section 10177(f) covers conduct showing the applicant/licensee is not honest and truthful

Section 10177(h) allows discipline for a broker's failure to reasonably supervise salespersons. Section 10177(l) prohibits inducement of panic selling (blockbusting) based on entry of persons of another race, color, religion, ancestry, or national origin. Section 10177(o) requires disclosure of ownership interest to buyers.

• ✓Section 10177(h) covers a broker's failure to exercise reasonable supervision over salespersons
• ✓Section 10177(l) prohibits panic selling/blockbusting based on protected classifications
• ✓Section 10177(o) requires disclosure of the licensee's ownership interest in the subject property

A misrepresentation is a false statement of fact; a false promise is a false statement about what the promisor will do (Section 10176(b)). A false promise is often proven by showing it was impossible to perform and the promisor knew it. Continued and flagrant misrepresentation is separately actionable under 10176(c).

• ✓A misrepresentation is a false statement of fact (10176(a))
• ✓A false promise is a false statement about what the promisor will do (10176(b))
• ✓Section 10176(c) covers a continued and flagrant course of misrepresentation or false promises

Section 10176(f) requires a specified termination date on all exclusive listings. Section 10176(g) covers secret profit, often via a dummy purchaser. Section 10176(h) requires a licensee using an option-and-listing form to disclose profit and obtain the principal's written consent before exercising the option.

• ✓Exclusive listings must include a specified definite termination date (10176(f))
• ✓Secret profit (10176(g)) arises when a broker profits secretly, often via a dummy purchaser
• ✓A listing-option requires disclosing profit and obtaining written consent before exercising (10176(h))

Section 10176(i) 'dishonest dealing' is a catch-all requiring acts needing a license. Section 10176(k) covers failing to disburse funds per a mortgage loan commitment when the broker represents itself as lender or authorized agent. Section 10176(l) prohibits intentionally delaying a mortgage loan closing to increase interest, costs, fees, or charges.

• ✓Section 10176(i) dishonest dealing requires acts requiring a license
• ✓Section 10176(l) prohibits delaying a loan closing solely to increase borrower charges
• ✓Section 10176(j) requires written authorization before securing a purchaser's signature for a business sale

California brokers use a deposit receipt when accepting earnest money with an offer to purchase. It is both a receipt and the basic contract, setting forth all sale factors including financing, deposit return terms if the offer is not accepted, and disposition if the buyer defaults. Terms must be written with extreme care.

• ✓The deposit receipt is both a receipt and the basic contract for the transaction
• ✓It should set forth all basic sale factors including financing and deposit disposition

The real estate license law requires brokers and salespersons to give copies of documents and agreements to signing persons at the time signatures are obtained. This applies to listings, deposit receipts, and any document related to licensed acts.

• ✓Copies of signed documents must be given to signers at the time of signing
• ✓This applies to all documents pertaining to licensed acts

A tender is an offer by a party to carry out its part of the contract, usually made at closing. If one party defaults, the other makes the tender to establish they were ready, willing, and able. If both parties were in default, neither may recover damages. Objections must be specified at tender or are waived; proper tender places the other party in default.

• ✓A tender is an offer to perform, usually made at closing
• ✓If both parties are in default, neither may recover damages
• ✓Objections must be specified at tender or are waived
• ✓Proper tender places the non-accepting party in default