The subject property is a fourplex. The owner's statement shows EGI of $60,000 and NOI of $38,000. It includes a $6,000 storm repair that is not expected to recur and no management expense because the owner self-manages. Management for similar fourplexes runs 8% of EGI. Recent sales of similar fourplexes indicate an overall rate of 6%. What is the indicated value?
Correct Answer
C) $653,333
A typical buyer would not expect the one-time repair but would expect to pay for management. Reconstructed NOI is $38,000 + $6,000 − $4,800 = $39,200, and $39,200 ÷ 0.06 = $653,333. Capitalizing the reported figure gives $633,333. Charging management without the add-back gives $553,333, and making the add-back without charging management gives $733,333.
Why This Is the Correct Answer
Option C is correct because a typical buyer would remove the non-recurring $6,000 repair and charge the $4,800 market management fee ($60,000 × 8%). That gives $38,000 + $6,000 − $4,800 = $39,200 of NOI. Dividing by 6% indicates $653,333.
Why the Other Options Are Wrong
Option A: $553,333
Option A, $553,333, charges management but leaves the storm repair in: ($38,000 − $4,800) ÷ 0.06. A one-time cost does not belong in stabilized expenses. The correct calculation is $39,200 ÷ 0.06 = $653,333.
Option B: $633,333
Option B, $633,333, capitalizes the reported figure: $38,000 ÷ 0.06. The two adjustments partly offset but do not cancel. The correct calculation is $39,200 ÷ 0.06 = $653,333.
Option D: $733,333
Option D, $733,333, adds back the repair but omits management: ($38,000 + $6,000) ÷ 0.06. A buyer would expect to pay for management even though this owner does not write a check for it. The correct calculation is $39,200 ÷ 0.06 = $653,333.
Owner's NOI is a draft
Treat a reported NOI as a first draft. Strip out what will not recur and add in what a typical buyer would have to pay.
How to use: Use this when an operating statement mentions one-time items or owner-provided services.
Exam Tip
Look for adjustments that run in opposite directions and make each one separately. Finish reconstructing the statement before you touch the capitalization rate.
Common Mistakes to Avoid
- -Capitalizing the owner's reported NOI without reconstructing it
- -Leaving out management because the owner pays no cash fee
- -Treating a one-time repair as a recurring operating expense
Concept Deep Dive
Analysis
The skill is capitalizing the income a typical buyer would project and not the owner's number. Two corrections are needed and they run in opposite directions. Work out each adjustment, reach reconstructed NOI, and then divide by the rate.
Background Knowledge
Value in the income approach rests on income and expenses a typical purchaser would project, not on one owner's bookkeeping. Non-recurring items are removed, and services the owner provides without charge are priced at market. The result is a stabilized NOI that fits a market-derived rate.
Real-World Application
The owner of a fourplex manages it personally and had a large storm repair last year. The appraiser removes the repair, adds a market management fee, and capitalizes the adjusted NOI rather than the figure on the owner's statement.
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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