The subject property is an office building in lease-up. In-place NOI is $96,000, and NOI at stabilized occupancy is projected at $120,000. Sales of stabilized office buildings in the market indicate an overall rate of 8%. Remaining rent loss until stabilization is estimated at $70,000, and remaining leasing commissions and tenant improvements at $110,000. What is the indicated as-is value?
Correct Answer
C) $1,320,000
Stabilized NOI matches the 8% rate: $120,000 ÷ 0.08 = $1,500,000. The building has not reached that level, so the $70,000 rent loss and $110,000 of leasing costs are deducted, giving $1,320,000. Stopping at $1,500,000 ignores the lease-up. Capitalizing in-place NOI gives $1,200,000, and also deducting the costs from that figure gives $1,020,000, which counts the shortfall twice.
Why This Is the Correct Answer
Option C is correct because the 8% rate belongs with stabilized NOI, so $120,000 ÷ 0.08 = $1,500,000 is the value as if stabilized. A buyer today still faces $70,000 of rent loss and $110,000 of leasing costs. Deducting that $180,000 leaves $1,320,000 as the as-is indication.
Why the Other Options Are Wrong
Option A: $1,020,000
Option A, $1,020,000, capitalizes the depressed in-place NOI ($96,000 ÷ 0.08 = $1,200,000) and then also deducts $180,000. The low NOI already reflects the vacancy, so the shortfall is counted twice. The correct figure is $1,500,000 − $180,000 = $1,320,000.
Option B: $1,200,000
Option B, $1,200,000, is $96,000 ÷ 0.08. It applies a rate from stabilized sales to income that is not stabilized and ignores the remaining costs. The correct figure is $120,000 ÷ 0.08 − $180,000 = $1,320,000.
Option D: $1,500,000
Option D, $1,500,000, is $120,000 ÷ 0.08 with nothing deducted. That is the value as if stabilized, not as is, because $180,000 of lease-up cost remains. The correct figure is $1,320,000.
Stabilize, then subtract the gap
Capitalize the income the rate was built on, then subtract what it costs to get there. Use one treatment of the shortfall, not two.
How to use: Use this when an assignment gives both in-place and stabilized NOI plus lease-up costs.
Exam Tip
Check which income the rate came from before choosing an NOI. If costs to reach stabilization are listed, the as-is answer normally sits below the as-if-stabilized value.
Common Mistakes to Avoid
- -Capitalizing in-place NOI at a rate taken from stabilized sales
- -Reporting the as-if-stabilized value as the as-is value
- -Deducting lease-up costs from a value already based on depressed NOI
Concept Deep Dive
Analysis
The skill is reaching an as-is value for a property that has not stabilized. The market rate comes from stabilized sales, so stabilized NOI is the figure to capitalize. The dollars still needed to get there are then taken off once as a lump sum.
Background Knowledge
Direct capitalization converts one year of stable income into value. A property in lease-up does not yet produce that income, so the appraiser capitalizes the stabilized level and then accounts for the cost and rent loss of reaching it. Banking guidance calls these deductions and discounts for partially leased buildings.
Real-World Application
A lender orders an as-is value on a new office building that is 70% leased. The appraiser capitalizes projected stabilized NOI at a market rate, then deducts remaining rent loss, commissions and tenant improvements, and reports both the as-is and as-stabilized figures.
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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Previous Question
Annual potential base rent is $340,000 with 8% combined loss on base rent only. Additional tenant reimbursements have already been forecast at collectible effective amounts of $12,500 and have no further loss. What total EGI results?
Next Question
An existing gross lease costs $36,000 per year including all specified services and expenses. Comparable identical space has annual base rent $30,000 plus $12,000 tenant-paid expenses, with otherwise identical rights and services. What is the annual cost advantage of the existing lease? This asks for annual benefit only.