The subject property's potential gross rent is $120,000 per year, with combined vacancy and collection loss of 8% of rent and no other income. All annual property expenses, including real estate taxes and reserves but excluding debt service, total $35,000. The overall rate is 9.5%. What is the indicated value, rounded to the nearest dollar?
Correct Answer
A) $793,684
120000×(1−0.08)−35000 = 75400; 75400÷0.095 = 793684.21. Common errors: not deducting the vacancy and collection loss gives $894,737; capitalizing EGI instead of NOI gives $1,162,105; applying the vacancy loss after deducting expenses gives $823,158.
Why This Is the Correct Answer
Option A is correct because $120,000 × (1 − 0.08) = $110,400 EGI, and $110,400 − $35,000 = $75,400 NOI. Capitalizing that NOI at 9.5% gives $75,400 ÷ 0.095 = $793,684.21, or $793,684 rounded.
Why the Other Options Are Wrong
Option B: $823,158
Option B, $823,158, applies the vacancy loss after deducting expenses: ($120,000 − $35,000) × 0.92 ÷ 0.095 = $823,158. Vacancy is taken from gross rent first: ($120,000 × 0.92 − $35,000) ÷ 0.095 = $793,684.
Option C: $894,737
Option C, $894,737, skips the vacancy and collection loss: ($120,000 − $35,000) ÷ 0.095 = $894,737. Deducting the 8% loss first gives NOI of $75,400 and a value of $793,684.
Option D: $1,162,105
Option D, $1,162,105, capitalizes EGI instead of NOI: $120,000 × 0.92 ÷ 0.095 = $1,162,105. Operating expenses of $35,000 must be deducted first, giving $75,400 ÷ 0.095 = $793,684.
PGI, EGI, NOI, then divide
Walk down the ladder in order: potential gross, minus vacancy, equals effective gross; minus expenses, equals NOI; NOI over rate equals value.
How to use: Use this ladder on income reconstruction questions so no step is skipped or reordered.
Exam Tip
Write out each line of the operating statement before dividing by the rate; wrong answers typically come from capitalizing a figure one line too early.
Common Mistakes to Avoid
- -Capitalizing EGI before deducting operating expenses
- -Leaving out vacancy and collection loss
- -Applying the vacancy percentage to income after expenses
Concept Deep Dive
Analysis
This question tests the full direct capitalization sequence: potential gross income, less vacancy and collection loss, equals effective gross income; less operating expenses equals NOI; then NOI divided by the overall rate gives value. The order matters because vacancy is a percentage of rent, not of rent after expenses. EGI is $110,400, NOI is $75,400, and $75,400 ÷ 0.095 = $793,684.
Background Knowledge
Direct capitalization converts a single year's NOI into value by dividing by an overall capitalization rate. NOI is reached by deducting vacancy and collection loss from potential gross income to get EGI, then deducting operating expenses but not debt service. The rate must be compatible with the way the income was defined.
Real-World Application
An appraiser valuing a small retail building estimates $120,000 of market rent, an 8% vacancy and collection allowance, and $35,000 of expenses including reserves. Capitalizing the resulting $75,400 NOI at a market-supported 9.5% rate indicates about $793,684.
More Income Approach Questions
Which stated cause of supported value loss is external?
Improvement cost new is $450,000. Separately supported improvement depreciation deductions of $45,000, $25,000, $15,000 are expressly nonoverlapping and not already excluded from cost new. Add supported site value of $125,000, already reflecting any site losses. What total indicated value results?
Which two depreciation categories may each be classified as curable or incurable by comparing the cost to remedy a deficiency with the value gained?
Improvement cost new is $800,000. Separately supported improvement depreciation deductions of $120,000, $80,000, $40,000 are expressly nonoverlapping and not already excluded from cost new. No site is included. What depreciated improvement amount results?
The principle of anticipation in real estate valuation states that:
Which highest-and-best-use criterion addresses whether a proposed use is allowed by zoning and applicable legal restrictions?
Three comparables produce adjusted indications of $312,000, $309,000 and $315,000, requiring gross adjustments of 9%, 14% and 22% respectively. Verification also establishes that the first sale is the closest competitive substitute and its adjustments are better supported than the other two. Which indication deserves the most weight on those facts?
When reconciling value indications from the three approaches to value, an appraiser should:
A property sold at a cash-equivalent price of $1,062,500. Its stabilized annual NOI is $85,000. What is the indicated overall rate?
In reconciliation, an appraiser should:
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