A property has potential gross income of $150,000, vacancy and collection loss of 5%, and operating expenses of $50,000. Using a gross income multiplier of 8.5, what is the indicated value?
Correct Answer
B) $1,207,500
Effective Gross Income = $150,000 × (1 - 0.05) = $142,500. Using GIM: $142,500 × 8.5 = $1,207,500. Note that operating expenses are not deducted when using a gross income multiplier.
Why This Is the Correct Answer
Option B correctly applies the GIM formula using effective gross income. First, the effective gross income is calculated: $150,000 × (1 - 0.05) = $142,500, accounting for the 5% vacancy and collection loss. Then, the GIM is applied: $142,500 × 8.5 = $1,207,500. The operating expenses of $50,000 are correctly ignored in this calculation, as GIM is based on gross income, not net income.
Why the Other Options Are Wrong
Option A: $1,062,500
This answer incorrectly deducts operating expenses from the effective gross income before applying the multiplier, calculating ($142,500 - $50,000) × 8.5 = $787,500, which is not even close to option A, suggesting a different calculation error.
Option C: $1,275,000
This answer uses the potential gross income instead of effective gross income, calculating $150,000 × 8.5 = $1,275,000, failing to account for the 5% vacancy and collection loss.
Option D: $1,417,500
This answer appears to use an incorrect multiplier or calculation method, possibly confusing GIM with another valuation approach or making computational errors in the process.
GIM-EGI Rule
Remember 'GIM uses EGI, Never NOI' - Gross Income Multiplier uses Effective Gross Income, Never Net Operating Income. Think 'GROSS means before expenses are taken out.'
How to use: When you see a GIM question, immediately identify the effective gross income (potential gross income minus vacancy/collection losses) and multiply by the GIM. If operating expenses are mentioned, remind yourself 'GIM uses EGI, Never NOI' and ignore the expenses.
Exam Tip
Always read GIM questions carefully to distinguish between potential gross income and effective gross income. If vacancy/collection losses are given, you must calculate effective gross income first. Never subtract operating expenses when using GIM.
Common Mistakes to Avoid
- -Subtracting operating expenses before applying the GIM
- -Using potential gross income instead of effective gross income
- -Confusing GIM with other multipliers like Net Income Multiplier or capitalization rates
Concept Deep Dive
Analysis
This question tests the application of Gross Income Multiplier (GIM) methodology in the income approach to valuation. The GIM is a quick valuation tool that relates property value to its effective gross income, not net operating income. Understanding the distinction between potential gross income, effective gross income, and net operating income is crucial, as GIM specifically uses effective gross income (gross income after vacancy and collection losses). The key insight is that operating expenses are irrelevant in GIM calculations, unlike other income approach methods such as direct capitalization.
Background Knowledge
Gross Income Multiplier (GIM) is a market-derived ratio that compares sale prices of comparable properties to their effective gross income. It provides a quick estimate of value by multiplying a property's effective gross income by the appropriate multiplier derived from market data. Effective gross income equals potential gross income minus vacancy and collection losses, but before operating expenses are deducted.
Real-World Application
Appraisers use GIM for quick property valuations, especially for income-producing properties like apartments or commercial buildings. Lenders and investors often use GIM as a screening tool because it's faster than detailed discounted cash flow analysis, though it's less precise than other income approach methods.
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