An appraiser estimates potential gross income for a lawful four-unit building at full occupancy and current market rents. One rentable unit is occupied rent-free by the owner. How is that unit included in PGI?
Correct Answer
A) At its market rent.
When potential income is estimated at market rents, include the rentable owner-occupied unit at supported market rent. Actual cash receipts are a different measure. Confirm the unit is lawful and available to the modeled rental use; PGI is not universally a market-rent figure in every leased-fee model.
Why This Is the Correct Answer
Option A is correct because a market-rent potential gross income model measures what each rentable unit could earn at prevailing market rent. Market rent is the rate prevailing for comparable properties, as distinguished from the actual receipts under the current arrangement. The owner's rent-free occupancy is a choice about use, not a limit on the unit's income capacity, so the unit is included at its supported market rent.
Why the Other Options Are Wrong
Option B: Excluded, since no cash changes hands.
Option B excludes the unit because no cash changes hands, but that measures actual cash receipts, not potential income at market rent. A lawful, rentable unit has market rental capacity whether or not the current owner pays rent.
Option C: At half its market rent.
Option C includes the unit at half its market rent, but nothing in the facts supports a 50% discount. The model calls for full-occupancy potential income at current market rents, so the supported market rent is the figure to use.
Option D: At the owner’s cost of living.
Option D uses the owner's cost of living, which is a personal expense figure with no connection to what comparable units rent for. Potential gross income is based on market rent for the space, not on the occupant's personal finances.
Price the space, not the occupant
In a market-rent PGI model, ask what the unit would rent for to a typical tenant, regardless of who lives there now. The occupant's arrangement does not shrink the space's earning capacity.
How to use: Use this when a question mentions owner-occupied, vacant or rent-free units in a potential income calculation.
Exam Tip
Check which income measure applies; if it is full-occupancy market-rent potential income, impute market rent to each lawful rentable unit. Questions about actual cash receipts or a leased-fee analysis may call for a different measure.
Common Mistakes to Avoid
- -Leaving out the owner-occupied unit because it produces no cash rent
- -Confusing actual cash receipts with potential gross income
- -Applying an arbitrary discount to an owner-occupied unit's rent
Concept Deep Dive
Analysis
This question tests how potential gross income is built when the model is expressly stated as full occupancy at current market rents. The key is to separate the income-generating capacity of the space from what the current owner happens to pay. Because the unit is lawful and rentable, its market rent belongs in a market-rent PGI model even though no cash is collected today.
Background Knowledge
Potential gross income is the total income a property could produce at full occupancy before vacancy and collection loss. Market rent is the rate prevailing for comparable space, while contract rent is the actual rent specified in a lease. In a market-rent model, owner-occupied or rent-free units that are lawful and rentable are typically imputed at market rent.
Real-World Application
An appraiser values a fourplex where the owner lives in one unit and rents the other three. Using market rent comparables for similar two-bedroom units, she imputes the same supported market rent to the owner's unit when building PGI for the income approach.
More Income Approach Questions
Which model describes yield capitalization of property benefits?
An appraiser is valuing a duplex. A market survey of recent duplex sales reports prices at 10.8 times potential gross income, with stabilized vacancy and credit loss of 10% of PGI and no other income. The subject's rent schedule is unavailable, but the property manager's records show collected income of $54,000 a year, in line with market rent and the 10% market loss. What value is indicated?
The subject property is a fourplex with annual EGI of $72,000 and operating expenses of $28,800. Of those expenses, $18,000 is fixed and $10,800 varies in direct proportion to EGI. The owner's annual mortgage payments are $21,000. An appraiser projects that EGI will fall 10% because of higher vacancy. What is the projected NOI?
Annual NOI available for debt service is $168,000 and total annual mortgage principal and interest debt service is $120,000. What is NOI ÷ debt service?
Annual PGI is $250,000 and combined vacancy and collection loss is explicitly 12% of that same PGI base. There is no other income. What annual EGI remains?
Annual PGI is $360,000 and combined vacancy and collection loss is explicitly 8% of that same PGI base. There is no other income. What annual EGI remains?
Annual PGI is $640,000. Combined vacancy and collection loss is 6.25% of PGI. There is no other income. What EGI remains?
An appraiser is updating a prior appraisal of a triplex with potential gross income of $60,000 and no other income. The prior appraisal used vacancy and credit loss of 5% of PGI, and a new survey of competing rentals indicates 8%. The operating expenses of $24,000 are property taxes, insurance and contract services that do not vary with occupancy, and the market overall rate remains 7.5%. By what percentages do effective gross income and indicated value decrease?
Annual potential rental income is $600,000 and vacancy loss alone is $36,000. What percentage of potential rent does that loss represent?
In the subject's market, lenders on fourplexes have lowered their typical loan-to-value ratio from 70% to 60%. The annual mortgage constant remains 5% and the equity dividend rate remains 10%. The subject's NOI has not changed. How does this affect the overall rate indicated by the band of investment and the indicated value?
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Previous Question
An appraiser is developing a stabilized rental income model to value the fee simple interest in a leased property. Contract rent is $1,100 and market rent is $1,275. Which rent is the appropriate base for the model?
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An appraiser is valuing a flex building with effective gross income of $220,000 and operating expenses, including property taxes, of $100,000. The owner's pro forma also lists a $4,000 replacement allowance and a $6,000 recurring leasing allowance. Comparable sales indicate an 8% overall rate, extracted from income after a replacement allowance and with no deduction for recurring leasing costs. What is the indicated value by direct capitalization?