An appraiser is reconstructing the owner's statement for a 12-unit apartment building with identical units. Market rent is $1,200 per month, and 11 units are leased to tenants at that rent with no vacancy. The twelfth unit is occupied rent-free by a resident manager as part of the manager's pay, along with a cash wage of $600 per month, an arrangement typical of competing buildings. The statement shows rent collected of $158,400, operating expenses of $60,000 that include the cash wage, and mortgage payments of $48,000, with no entry for the manager's unit. What potential gross income and operating expenses should the reconstructed statement show?
Correct Answer
A) PGI of $172,800; operating expenses of $74,400
All 12 units count at market rent in PGI: 12 × $1,200 × 12 = $172,800. The manager's rent-free unit is part of the manager's pay, so its $14,400 annual rent is added to expenses: $60,000 + $14,400 = $74,400. Accepting the statement as written leaves out both entries, and changing only one side either overstates NOI by the full $14,400 or understates it by the same amount. Mortgage payments are not operating expenses.
Why This Is the Correct Answer
Option A is correct because potential gross income covers all 12 units at market rent: 12 × $1,200 × 12 = $172,800. The unit is also part of the manager's pay, so its $14,400 annual rent joins the $60,000 of expenses, giving $74,400.
Why the Other Options Are Wrong
Option B: PGI of $158,400; operating expenses of $60,000
Option B, PGI of $158,400 and expenses of $60,000, simply repeats the owner's statement. It omits the twelfth unit's $14,400 market rent from PGI and the same $14,400 of manager compensation from expenses, so both lines are understated.
Option C: PGI of $172,800; operating expenses of $60,000
Option C, PGI of $172,800 and expenses of $60,000, corrects income only. It treats the $600 cash wage as the manager's whole pay, leaving out the $14,400 unit and overstating NOI; expenses should be $74,400.
Option D: PGI of $158,400; operating expenses of $74,400
Option D, PGI of $158,400 and expenses of $74,400, charges the rent-free unit as compensation but leaves its rent out of PGI. That counts the cost without the income; PGI should be 12 × $1,200 × 12 = $172,800.
Free Unit, Two Entries
A rent-free unit is earned as rent and paid out as wages. Write it once on the income side and once on the expense side.
How to use: Use the two-entry check whenever a statement shows a unit occupied by staff with no rent recorded.
Exam Tip
Non-cash items can be missing from an owner's statement and still belong in a reconstruction. Ask what the unit could rent for and what the owner is giving up to pay the manager.
Common Mistakes to Avoid
- -Treating the cash wage as the manager's total compensation
- -Counting only tenant-occupied units in potential gross income
- -Including mortgage payments in operating expenses
Concept Deep Dive
Analysis
The owner's statement is silent on the manager's unit because no cash changes hands, but the unit could rent at market and the manager's pay includes its use. Reconstruction shows both sides: the unit's market rent in potential gross income and the same amount as management compensation. The candidate must also keep mortgage payments out of operating expenses.
Background Knowledge
Potential gross income is the income a property could produce at full occupancy before any loss or expense. Management cost is an expense however it is paid, including through use of a unit rather than cash. Showing a manager's unit on both sides keeps the statement comparable with properties that pay managers entirely in cash.
Real-World Application
An appraiser reviews the books of an apartment building whose manager lives on site without paying rent. The appraiser adds the unit's market rent to PGI and an equal amount to management cost, so the expense ratio can be compared with buildings that pay managers only in cash.
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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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?