The subject property has annual EGI of $99,000. Operating expenses other than reserves total $29,700, and the annual reserve is $3,300. The 8% overall rate was extracted from sales with income stated after the same reserve. What value is indicated?
Correct Answer
B) $825,000
(99000−29700−3300)÷0.08 = 825000. Common errors: leaving out the reserve gives $866,250; capitalizing EGI instead of NOI gives $1,237,500; reporting the NOI without capitalizing it gives $66,000.
Why This Is the Correct Answer
Option B is correct because NOI after reserve is $99,000 - $29,700 - $3,300 = $66,000, and $66,000 / 0.08 = $825,000. The rate and the NOI share the same after-reserve convention.
Why the Other Options Are Wrong
Option A: $66,000
Option A, $66,000, is the NOI itself: $99,000 - $29,700 - $3,300 = $66,000. The question asks for value, so the NOI is capitalized: $66,000 ÷ 0.08 = $825,000.
Option C: $866,250
Option C, $866,250, leaves out the reserve: ($99,000 - $29,700) / 0.08. Since the rate is after reserves, the $3,300 must be deducted, giving $825,000.
Option D: $1,237,500
Option D, $1,237,500, capitalizes EGI instead of NOI: $99,000 / 0.08. Expenses and the reserve must be deducted first, giving $66,000 / 0.08 = $825,000.
Rate basis sets income basis
If the rate is after reserves, the income must be after reserves too.
How to use: Use this to decide whether to deduct a reserve before capitalizing.
Exam Tip
Check the stated convention of the cap rate first, then build NOI to match it.
Common Mistakes to Avoid
- -Omitting a reserve when the cap rate is after reserves
- -Capitalizing EGI instead of NOI
- -Stopping at NOI without capitalizing it
Concept Deep Dive
Analysis
This question tests matching the reserve treatment in NOI to the cap rate convention. Because the 8% rate is stated after reserves, the $3,300 reserve is deducted once along with operating expenses before capitalizing.
Background Knowledge
A replacement reserve is an annual allowance for replacing short-lived building components. Whether it is deducted in NOI varies, so the NOI used must match the convention on which the cap rate was derived.
Real-World Application
An appraiser's market survey reports cap rates after a reserve for replacements. She therefore deducts a reserve in the subject's NOI before capitalizing so that income and rate are on the same basis.
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?
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A lease explicitly allocates the named property taxes, insurance and maintenance to the tenant in addition to base rent. Which description fits these stated conventional terms?
Next Question
The subject property is a fourplex with market rent of $2,500 per unit per month. One unit was empty all of last year, and the owner's statement shows rent collected of $90,000, property taxes and insurance of $18,000, utilities and maintenance of $9,000 that vary in direct proportion to occupancy, and mortgage payments of $36,000. The stabilized vacancy/credit loss allowance for similar properties is 5% of PGI. What is the projected stabilized net operating income?