A property generates $180,000 in potential gross income. Vacancy and collection losses are 8%, and operating expenses are $65,000. Using a gross income multiplier of 7.2, what is the indicated value?
Correct Answer
B) $1,195,200
Effective Gross Income = $180,000 × (1 - 0.08) = $165,600. Using GIM: Value = Effective Gross Income × GIM = $165,600 × 7.2 = $1,195,200.
Why This Is the Correct Answer
Option B correctly follows the two-step GIM process: first calculating Effective Gross Income by reducing the $180,000 potential gross income by 8% vacancy/collection losses to get $165,600, then multiplying by the GIM of 7.2. The calculation is: $180,000 × (1 - 0.08) = $165,600, then $165,600 × 7.2 = $1,195,200. This demonstrates proper understanding that GIM is applied to effective gross income, not potential gross income or net operating income.
Why the Other Options Are Wrong
Option A: $1,296,000
Option A incorrectly applies the GIM of 7.2 to the full potential gross income of $180,000 without accounting for vacancy and collection losses, resulting in $180,000 × 7.2 = $1,296,000, which overstates the property value.
Option C: $581,400
Option C appears to subtract operating expenses from effective gross income before applying the GIM, which is incorrect methodology since GIM uses gross income, not net income ($165,600 - $65,000 = $100,600, then some manipulation to reach this figure).
Option D: $1,166,400
Option D likely represents an error in the vacancy calculation or GIM application, possibly using an incorrect effective gross income figure in the multiplication process.
PEG the GIM
PEG: Potential income → Effective income (subtract vacancy) → GIM multiplication. Remember 'PEG' - you're pegging the value by going from P to E to G(IM).
How to use: When you see a GIM question, think 'PEG': start with Potential income, convert to Effective income by subtracting vacancy/collection losses, then apply the GIM multiplier to get your final value.
Exam Tip
Always check whether the income figure given is potential or effective gross income - if vacancy/collection losses are mentioned separately, you must calculate effective gross income first before applying the GIM.
Common Mistakes to Avoid
- -Applying GIM to potential gross income instead of effective gross income
- -Subtracting operating expenses before applying GIM (confusing with Net Income Multiplier)
- -Forgetting to account for vacancy and collection losses in the income calculation
Concept Deep Dive
Analysis
This question tests the application of the Gross Income Multiplier (GIM) method, which is a quick valuation technique used in the income approach to appraisal. The key concept being tested is the proper calculation of Effective Gross Income by deducting vacancy and collection losses from Potential Gross Income, then applying the GIM to determine property value. Students must understand that GIM is applied to effective gross income, not potential gross income, and that operating expenses are not used in GIM calculations (unlike Net Income Multiplier calculations). This method provides a rapid market-based valuation tool commonly used for income-producing properties.
Background Knowledge
The Gross Income Multiplier (GIM) is a market-derived ratio that relates a property's sale price to its effective gross income, providing a quick valuation method for income properties. Effective Gross Income is calculated by subtracting vacancy and collection losses from Potential Gross Income, representing the actual income a property can reasonably be expected to generate.
Real-World Application
Appraisers use GIM for quick property valuations when comparing similar income properties, such as apartment buildings or retail centers, where market data shows consistent relationships between gross income and sale prices in a specific market area.
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