The subject property has annual potential base rental income of $122,000. Vacancy and collection loss is 5% of base rent. Other real property operating income, already net of its own collection loss, is $7,200. Annual property operating expenses are $21,600, including property taxes and any replacement reserve but excluding debt service. The overall capitalization rate is 10%. What is the indicated value, to the nearest dollar?
Correct Answer
C) $1,015,000
Base-rent loss = $122,000 × 0.05 = $6,100. Effective gross income = $122,000 − $6,100 + $7,200 = $123,100. NOI = $123,100 − $21,600 = $101,500. Direct capitalization gives $101,500 ÷ 0.1 = $1,015,000.00, or $1,015,000 to the nearest dollar. The other income is explicitly attributed to the real property, not an unvalued separate business enterprise.
Why This Is the Correct Answer
Option C is correct because the vacancy loss is $122,000 × 0.05 = $6,100, so effective gross income is $122,000 − $6,100 + $7,200 = $123,100. NOI is $123,100 − $21,600 = $101,500. Capitalizing at 10% gives $101,500 ÷ 0.10 = $1,015,000.
Why the Other Options Are Wrong
Option A: $1,220,000
Option A, $1,220,000, results from capitalizing the potential base rent directly: $122,000 ÷ 0.10. It ignores vacancy, other income and expenses; the correct NOI of $101,500 ÷ 0.10 gives $1,015,000.
Option B: $1,231,000
Option B, $1,231,000, results from capitalizing effective gross income of $123,100 at 10% instead of NOI. Deducting the $21,600 expenses first gives $101,500 ÷ 0.10 = $1,015,000.
Option D: $1,159,000
Option D, $1,159,000, results from capitalizing only the base rent after vacancy: $122,000 × 0.95 = $115,900, then ÷ 0.10. It omits the $7,200 other income and the $21,600 expenses; the correct value is $101,500 ÷ 0.10 = $1,015,000.
PGI, EGI, NOI, then divide
Go line by line: potential, minus vacancy, plus other income, equals effective; minus expenses equals NOI; then divide by the rate.
How to use: Use this sequence to make sure you capitalize NOI and not an earlier income line.
Exam Tip
If your answer matches gross income or EGI divided by the rate, you skipped a deduction; finish the reconstruction before dividing.
Common Mistakes to Avoid
- -Capitalizing effective gross income instead of NOI
- -Deducting vacancy again from other income that is already net
- -Leaving other real-property income out of effective gross income
Concept Deep Dive
Analysis
This question tests the full income reconstruction followed by direct capitalization. You deduct vacancy from base rent only, add other income that is already net, subtract operating expenses to reach NOI, and divide by the rate. The wrong answers capitalize income lines that come before NOI.
Background Knowledge
Potential gross income less vacancy and collection loss plus other income gives effective gross income. Operating expenses, including property taxes and reserves but excluding debt service, are deducted to reach NOI. Direct capitalization divides NOI by a compatible overall rate.
Real-World Application
An appraiser values a small mixed-use building with apartment rents and laundry income. Vacancy is applied to apartment rent, the laundry income is added net of its own loss, and stabilized expenses including taxes and reserves are deducted. The NOI is capitalized at a market-supported overall rate.
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?
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Previous Question
An appraiser values a property by direct capitalization at a 6% overall rate. If annual NOI decreases by $12,000 and the rate does not change, by how much does the indicated value decrease?
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A lender will fund 70% of value at an annual mortgage constant of 8%. The remaining equity requires an annual equity dividend rate of 12%. Annual NOI is $92,000. Using the band of investment to develop the overall rate, what value is indicated, rounded to the nearest dollar?