The subject property has annual PGI of $112,000, combined vacancy and collection loss of 5% and no other income. Property expenses are $18,000, and an annualized leasing-cost allowance, not included in that figure, is $7,000. The 10% capitalization rate was derived from income stated after the same allowance. What value is indicated?
Correct Answer
A) $814,000
(112000×0.95−18000−7000)÷0.10 = 814000. Common errors: leaving out the leasing-cost allowance gives $884,000; not deducting the 5% loss gives $870,000; capitalizing EGI instead of NOI gives $1,064,000.
Why This Is the Correct Answer
Option A is correct because EGI is $112,000 × 0.95 = $106,400. Deducting $18,000 of expenses and the $7,000 leasing allowance gives NOI of $81,400. At a 10% rate built on that same convention, value is $81,400 ÷ 0.10 = $814,000.
Why the Other Options Are Wrong
Option B: $870,000
Option B, $870,000, skips the 5% loss: ($112,000 − $18,000 − $7,000) ÷ 0.10. Vacancy and collection loss must come off first, giving ($106,400 − $25,000) ÷ 0.10 = $814,000.
Option C: $884,000
Option C, $884,000, leaves out the leasing-cost allowance: ($112,000 × 0.95 − $18,000) ÷ 0.10. Since the cap rate assumes that allowance is deducted, the correct result is $814,000.
Option D: $1,064,000
Option D, $1,064,000, capitalizes EGI instead of NOI: $112,000 × 0.95 ÷ 0.10. Expenses and the leasing allowance totaling $25,000 must be deducted, giving $814,000.
Match income to rate
The cap rate and the NOI must speak the same language. If the rate was built after a leasing allowance, your NOI must also be after that allowance.
How to use: Use this check whenever a problem states that the rate is based on a particular income convention.
Exam Tip
When a cap rate is derived from income after an allowance, deduct that allowance once along with the expenses. The distractors usually omit one step at a time.
Common Mistakes to Avoid
- -Ignoring an explicit leasing-cost allowance
- -Forgetting to deduct vacancy and collection loss
- -Dividing EGI by the cap rate
Concept Deep Dive
Analysis
This question tests whether you deduct an explicit leasing-cost allowance when the cap rate is based on the same income convention. Because the rate assumes NOI after that allowance, the allowance must be subtracted exactly once along with vacancy and other expenses. Mixing conventions between income and rate distorts value.
Background Knowledge
Income and capitalization rate must be stated on a consistent basis. If market rates are extracted from NOI that is net of leasing costs or reserves, the subject's NOI must also deduct them. Deducting such an item twice, or not at all, produces an inconsistent value.
Real-World Application
An appraiser valuing a multi-tenant office building finds that local investors deduct annualized leasing commissions and tenant improvements before extracting cap rates. He therefore deducts the same allowance from the subject's income before capitalizing.
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
An appraiser extracted an overall rate from sales of similar office buildings, and the income from those sales had no deduction for recurring leasing commissions. The subject office building is at stabilized occupancy, and its owner's budget shows $8,000 a year for recurring leasing commissions. In direct capitalization at the extracted rate, how should the appraiser treat the $8,000?
Next Question
Annual EGI is $500,000 and all specified annual operating expenses total $215,000, excluding debt service. Using EGI as the denominator, what operating expense ratio results?