Income Approachmedium8.2% of exam

A four-unit building has one unit the owner occupies rent-free. How is that unit treated in potential gross income?

Correct Answer

A) At its market rent, like every other unit

Why this is correct: Potential Gross Income (PGI) is the total market rent the property could generate if all units were leased at market rates. Owner-occupancy is a personal use decision; the unit's rental potential remains. Why the other choices are wrong: 'Excluded, because it produces no cash' confuses actual income with potential income. 'At half of market rent as a compromise' has no analytical basis. 'At the owner's imputed cost of living there' is not a market rent concept. Exam tip: PGI is based on 100% occupancy at market rents, regardless of actual occupancy.

Answer Options

At its market rent, like every other unit

Excluded, because it produces no cash

At half of market rent as a compromise

At the owner's imputed cost of living there

Why This Is the Correct Answer

Option A is correct because PGI is measured at 100 percent occupancy at market rent for every unit, regardless of who occupies it or on what terms. The owner's unit has the same physical utility and would rent for the same amount as its counterparts, so excluding or discounting it would understate the property's income capacity. Market rent for that unit is supported by the same rent comparables used for the rest of the building. Any actual shortfall belongs in vacancy and collection loss, not in the PGI line.

Why the Other Options Are Wrong

Option B: Excluded, because it produces no cash

This confuses effective cash received with potential income. PGI deliberately ignores current occupancy and current lease terms so that the estimate reflects the property rather than the owner. Excluding the unit would drop roughly a quarter of the building's income capacity and produce a value indication no buyer or lender would accept.

Option C: At half of market rent as a compromise

There is no split-the-difference convention in income analysis. Half of market rent is neither the unit's market rent nor its actual contract rent, so the figure corresponds to nothing observable. Compromise numbers of this kind are a classic distractor because they feel cautious while actually being unsupported.

Option D: At the owner's imputed cost of living there

The owner's cost of living in the unit is a personal expense measure, not a rental market measure. It might equal, exceed, or fall short of market rent depending on the owner's finances, and none of that tells you what a tenant would pay. Income analysis is built from market rent evidence, not from an occupant's household budget.

PGI is the building's resume

PGI describes what the building could earn if every door were leased at market, the way a resume lists capability rather than this month's paycheck. The owner sleeping in one unit is a lifestyle fact, not a property fact.

How to use: Whenever a stem introduces an unusual occupancy (owner-occupied, family at a discount, a friend paying nothing), immediately substitute market rent and keep moving down the income statement.

Exam Tip

Any answer choice that adjusts PGI for who is living somewhere is wrong. PGI changes only when market rent or the unit count changes.

Common Mistakes to Avoid

-Building PGI from the rent roll's actual collections instead of market rent
-Excluding an owner-occupied or vacant unit from potential income
-Double-counting vacancy by both excluding the unit and applying a vacancy factor
-Using below-market family rent as if it were market evidence

Concept Deep Dive

Analysis

This question tests the definition of potential gross income and the discipline of appraising the real property rather than the current owner's arrangements. Potential gross income is the total income the property would produce at full occupancy at market rent, before any deduction for vacancy, collection loss, or expenses. It is a property attribute, not a cash-flow report, so an owner's decision to live in one unit rent-free is a personal choice that does not change what the unit could command. The appraiser estimates market rent for that unit from rental comparables exactly as for the other three, includes it in PGI, and then handles real-world emptiness through the vacancy and collection loss line. Keeping owner units at market rent is also what makes the subject's income statement comparable to the sales and rentals used to derive the multiplier or capitalization rate.

Background Knowledge

You need the income sequence: potential gross income, less vacancy and collection loss, plus other income, equals effective gross income; less operating expenses equals net operating income. You also need to know that market rent, not contract rent, drives PGI, and that owner-occupied or below-market family-occupied units are still valued at market rent.

Real-World Application

Appraising an owner-occupied fourplex for a refinance, you pull four rental comparables in the neighborhood, set market rent for all four units including the owner's, and build PGI from those figures. The lender's underwriting then applies its own vacancy factor, and the analysis holds together because you never mixed actual cash flow into the potential line.

potential gross incomemarket rentowner-occupied unitvacancy and collection lossincome approach

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