The subject property is a four-unit apartment building whose owner manages it personally, pays no management fee and takes a $1,200 annual personal draw that does not appear on the operating statement. Effective gross income is $60,000 and the statement's expenses, including property taxes, total $24,000. Managers of competing buildings charge 5% of effective gross income. Sales of similar properties, analyzed with market management deducted, indicate an 8% overall rate. What is the indicated value by direct capitalization?
Correct Answer
A) $412,500
A typical buyer would expect to pay for management, so the market fee of $60,000 × 0.05 = $3,000 is deducted even though no fee is paid. NOI = $60,000 − $24,000 − $3,000 = $33,000, and $33,000 ÷ 0.08 = $412,500. Leaving management out gives $450,000, using the owner's draw in place of the market fee gives $435,000, and subtracting the fee from value instead of income gives $447,000.
Why This Is the Correct Answer
Option A is correct because the market fee of 5% × $60,000 = $3,000 belongs in the operating statement even though the owner writes no check for it. NOI is $60,000 − $24,000 − $3,000 = $33,000, and $33,000 ÷ 0.08 = $412,500. This also matches the rate, which was extracted from sales with market management deducted.
Why the Other Options Are Wrong
Option B: $435,000
Option B, $435,000, deducts the owner's $1,200 personal draw in place of the market fee: ($60,000 − $24,000 − $1,200) ÷ 0.08 = $435,000. A personal draw is not the market cost of management; the correct deduction is $3,000, giving $412,500.
Option C: $447,000
Option C, $447,000, capitalizes income with no fee and then subtracts one year's fee from value: $36,000 ÷ 0.08 − $3,000 = $447,000. A recurring annual cost must reduce income before capitalization, which gives $33,000 ÷ 0.08 = $412,500.
Option D: $450,000
Option D, $450,000, omits management because no cash is paid: ($60,000 − $24,000) ÷ 0.08 = $450,000. That overstates income a buyer could expect, because management has a market cost; the correct value is $33,000 ÷ 0.08 = $412,500.
Owner's labor still has a price
If the owner does the job for free, charge the property what a hired manager would cost. The draw goes in the owner's pocket; the fee goes on the statement.
How to use: Use this whenever a statement shows no management line on a self-managed property.
Exam Tip
When the owner self-manages and a competitive fee is given, expect to impute that fee. Check what base the percentage applies to before you calculate it.
Common Mistakes to Avoid
- -Leaving management out because no cash fee was paid
- -Using the owner's personal draw as the management expense
- -Subtracting a recurring fee from value instead of from income
Concept Deep Dive
Analysis
The issue is whether you model the income a typical buyer would expect rather than the owner's actual cash outlays. A self-managing owner still supplies a service that has a market cost, so the fee must be imputed at the competitive rate. Work out the fee on effective gross income, deduct it with the other expenses, and capitalize the result.
Background Knowledge
Market-value income models use the income and expenses a typical buyer would project, not the current owner's personal arrangements. Management is an operating expense of the property whether it is bought from an outside firm or supplied by the owner. The owner's compensation as an investor is a different matter and is not the measure of the fee.
Real-World Application
An appraiser reviews a small apartment building whose owner collects rents and handles repairs personally. The statement shows no management line, so the appraiser surveys local managers, applies their typical percentage of effective gross income and deducts that amount 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?
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Previous Question
An appraiser is reconstructing the operating statement of a duplex from the owner's statement for the first nine months of the year. It shows rent collected of $40,500; utilities and routine maintenance, paid monthly, of $5,400; the annual property tax bill, paid in full, of $6,000; the annual insurance premium, paid in full, of $2,400; and mortgage payments of $9,900. Rents and monthly costs have been level and are typical of the market, and no other income or expense is expected. What is the annual net operating income?
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