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
A) $1,211,250
Why this is correct: a gross income multiplier is applied to gross income, not to net. Effective gross income is potential gross income less vacancy and collection loss: $150,000 x (1 - 0.05) = $142,500. Applying the multiplier: $142,500 x 8.5 = $1,211,250. The $50,000 of operating expenses plays no part -- deducting expenses would take you to net operating income, which is capitalized rather than multiplied. Why the other choices are wrong: $1,275,000 is potential gross income multiplied by 8.5, which skips the vacancy deduction and so values income the property never collects; $1,417,500 and $1,062,500 do not follow from these figures by any route. Exam tip: a multiplier has to be applied to the same income measure it was derived from. A vacancy rate in the question is telling you the basis is effective gross income.
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
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.
More Income Approach Questions
A property generates $85,000 in Net Operating Income and sells for $1,062,500. What is the overall capitalization rate?
A property has potential gross income of $180,000, vacancy and collection loss of $15,000, and operating expenses of $65,000. What is the Net Operating Income?
A comparable sale occurred 8 months ago for $425,000. Market conditions indicate property values have increased 0.5% per month since that time. What is the adjusted sale price?
A property generates $150,000 in potential gross income. Market data indicates a 7% vacancy rate and operating expenses of 35% of effective gross income. If the cap rate is 9.5%, what is the indicated value?
A property sold for $320,000 one year ago. If market conditions have improved by 6% since that sale, what is the time-adjusted sale price for comparison purposes?
A commercial building cost $2,500,000 to construct. The land value is $600,000. If the building has suffered 15% physical deterioration and 8% functional obsolescence, what is the depreciated cost of the improvements?
A building's gross rent multiplier (GRM) is 120. If the monthly rent is $2,500, what is the indicated value?
In the cost approach, economic obsolescence is characterized as:
The concept of regression in property values means that:
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