A property has annual EGI of $48,000 after all rental losses. All property expenses total $18,000, excluding debt service. At an 8% overall rate, what is the indicated value?
Correct Answer
B) $375,000
(48000−18000)÷0.08 = 375000. Common errors: capitalizing EGI instead of NOI gives $600,000; misplacing the decimal in the 8% rate gives $37,500; adding the expenses instead of deducting them gives $825,000.
Why This Is the Correct Answer
Option B is correct because NOI is $48,000 − $18,000 = $30,000, and $30,000 ÷ 0.08 = $375,000. Direct capitalization divides NOI, not EGI, by the overall rate.
Why the Other Options Are Wrong
Option A: $37,500
Option A, $37,500, comes from misplacing the decimal in the 8% rate: ($48,000 − $18,000) ÷ 0.8 = $37,500. Eight percent is 0.08, giving $30,000 ÷ 0.08 = $375,000.
Option C: $600,000
Option C, $600,000, results from capitalizing EGI instead of NOI: $48,000 ÷ 0.08 = $600,000. Expenses must be deducted first, so the correct value is ($48,000 − $18,000) ÷ 0.08 = $375,000.
Option D: $825,000
Option D, $825,000, comes from adding the expenses instead of deducting them: ($48,000 + $18,000) ÷ 0.08 = $825,000. The correct NOI is $48,000 − $18,000 = $30,000, which capitalizes to $375,000.
IRV: Income over Rate is Value
Value equals Income divided by Rate, where the income is NOI after operating expenses. Get to NOI before you divide.
How to use: Use IRV on any direct capitalization question after confirming you have NOI.
Exam Tip
Write out the income ladder (PGI, EGI, NOI) and confirm which rung you are on before dividing by the cap rate.
Common Mistakes to Avoid
- -Capitalizing EGI instead of NOI
- -Entering 8% as 0.8 instead of 0.08
- -Deducting debt service as an operating expense
Concept Deep Dive
Analysis
This question tests the sequence from effective gross income to net operating income and then to value by direct capitalization. Deduct the $18,000 of expenses from the $48,000 EGI to get NOI, then divide NOI by the 8% overall rate. Debt service is excluded, as it is not an operating expense.
Background Knowledge
The income reconstruction runs from potential gross income, less vacancy and collection loss, to effective gross income, less operating expenses, to net operating income. Direct capitalization divides NOI by an overall capitalization rate. Debt service is a financing cost and is not deducted to reach NOI.
Real-World Application
An appraiser reviewing a fourplex receives an owner statement showing EGI and operating expenses, plus mortgage payments. The appraiser deducts only the operating expenses to reach NOI and capitalizes it at a market-derived rate.
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