A property's rent roll shows several units leased below the rest. Before projecting income the appraiser should:
Correct Answer
C) Determine whether those leases are below market and why
Why this is correct: In the income approach, the appraiser must analyze contract rents versus market rents. Determining why some units are leased below market (e.g., old lease, concessions, inferior unit) is essential to project future income accurately, whether using contract or market rent. Why the other choices are wrong: 'Exclude the below-market units from the income analysis' is incorrect; all leased space must be considered. 'Average all rents and apply the result' is wrong; it fails to analyze the cause of the variance. 'Assume the rents will rise at renewal' is an unsupported assumption; analysis must be based on evidence. Exam tip: Never blindly average rents. Analyze why each rent is what it is.
Why This Is the Correct Answer
Option C is correct because the analysis of why leases sit below market is the necessary predicate to any credible income projection. The cause determines the treatment: temporary legacy leases roll to market at expiration, concessions require converting face rent to effective rent, and genuinely inferior units justify a permanently lower market rent for that space. This analysis also feeds the leased fee conclusion, since a below-market lease reduces the owner's interest for as long as it runs. Skipping the diagnosis means guessing at the numerator of the entire income approach.
Why the Other Options Are Wrong
Option A: Exclude the below-market units from the income analysis
Excluding leased units removes real revenue-producing space from the analysis and would understate both potential gross income and the property's physical unit count. Every unit contributes income capacity whether or not its current rent is at market. The presence of a below-market lease is information to be analyzed, not a reason to delete the unit from the property.
Option B: Average all rents and apply the result
Averaging all rents blends market and below-market leases into a single figure that describes neither. It buries the very information the appraiser needs, since the average conceals both how far below market the laggards are and how soon they roll. A mechanical average also cannot distinguish a lease expiring next quarter from one with eight years remaining, though those have very different value effects.
Option D: Assume the rents will rise at renewal
Assuming rents will rise at renewal is an unsupported forecast rather than an analysis. Some leases contain renewal options at fixed or below-market rates that prevent any reset, and some markets soften so that even expiring leases renew at lower rents. The appraiser must read the lease terms and test the assumption against market evidence rather than presume improvement.
Read the lease before you read the rent
A rent roll is a symptom; the lease is the diagnosis. Ask three questions of every low rent: how far below market, how long remaining, and why. Only then project.
How to use: When a stem describes rents that vary, choose the option that investigates before projecting. Any answer that deletes data, averages it away, or forecasts without support is a distractor.
Exam Tip
In income approach questions, the answer that calls for analysis usually beats the answer that calls for a shortcut. Examiners test whether you gather the facts before you run the math.
Common Mistakes to Avoid
- -Projecting the rent roll forward without comparing it to market rent
- -Averaging disparate rents into one figure
- -Ignoring remaining lease terms when timing the reset to market
- -Overlooking concessions that make face rent higher than effective rent
Concept Deep Dive
Analysis
This tests the analytical step that must precede any income projection: understanding the relationship between contract rent and market rent, and the reason for any gap. A rent roll reports what tenants currently pay, but the appraiser needs to know why some units pay less before deciding what the property will produce going forward. The explanations lead to very different conclusions. Legacy leases signed years ago in a rising market will reset at expiration, so the shortfall is temporary and its effect is measured over the remaining term. Concessions or free rent buried in an otherwise market lease mean the effective rent differs from the face rent. A physically inferior unit, a poor location within the building, or a below-market related-party arrangement each carry their own treatment. Only after diagnosing the cause can the appraiser decide whether to project market rent, contract rent, or contract rent stepping to market at rollover.
Background Knowledge
You need to distinguish contract rent from market rent and to understand lease analysis, including remaining term, escalation and renewal clauses, concessions, and tenant improvement allowances. You also need to know that below-market contract rent creates a leasehold advantage that reduces the leased fee, and that the property rights appraised determine which rent drives the projection.
Real-World Application
A rent roll shows four of twenty units renting $250 below the rest. Reading the leases, you find three are long-tenured residents on legacy rents expiring within a year and one is a ground-floor unit facing a loading dock. You project the three to market at rollover and set a permanently lower market rent for the fourth, explaining both conclusions in the report.
More Income Approach Questions
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An appraiser is analyzing a mixed-use property with retail and office components. The retail segment has a potential gross income of $180,000 with a market vacancy of 8%. The office segment has a potential gross income of $120,000 with a market vacancy of 12%. What is the overall effective gross income for the property?