The subject property is a triplex. Its operating statement shows PGI of $52,000, EGI of $48,000 and operating expenses of $19,200, including a $2,400 replacement reserve. The appraiser's survey of similar triplexes shows operating expense ratios of 33% to 37% of EGI, all reported with no replacement reserve in expenses. On the same basis as the survey, what is the subject's operating expense ratio, and how does it compare with the survey?
Correct Answer
A) 35%, within the survey range
The survey ratios exclude reserves and are based on EGI, so the subject's reserve comes out first: ($19,200 − $2,400) ÷ $48,000 = 35%, which is within the 33% to 37% range. Leaving the reserve in gives 40% and makes the expenses look high. Adding the reserve a second time gives 45%. Dividing by PGI gives 32.3% and makes them look low.
Why This Is the Correct Answer
Option A is correct because the survey ratios exclude reserves and are stated on EGI. Removing the reserve leaves $16,800 of expenses, and $16,800 ÷ $48,000 = 35%. That figure falls inside the 33% to 37% range, so the subject's expenses are in line with the survey.
Why the Other Options Are Wrong
Option B: 32.3%, below the survey range
Option B shows 32.3%, which comes from dividing $16,800 by PGI of $52,000. The survey ratios are based on EGI, so the correct calculation is $16,800 ÷ $48,000 = 35%, and the subject is not below the range.
Option C: 40%, above the survey range
Option C shows 40%, which is $19,200 ÷ $48,000 with the reserve still in the numerator. The survey ratios have no reserve in expenses, so this compares two different bases; the comparable figure is ($19,200 − $2,400) ÷ $48,000 = 35%.
Option D: 45%, above the survey range
Option D shows 45%, which results from adding the reserve to a total that already includes it: ($19,200 + $2,400) ÷ $48,000. The reserve should come out, giving 35%, so the subject is not above the range.
Same top, same bottom
Before comparing two ratios, match the top (which expenses are in) and the bottom (PGI or EGI).
How to use: Use this check whenever a subject's expense ratio looks out of line with a market survey.
Exam Tip
When the facts say how comparable ratios were reported, restate the subject on that basis before drawing any conclusion. A ratio that looks high or low on the statement may be normal once the basis matches.
Common Mistakes to Avoid
- -Comparing a ratio that includes reserves with survey ratios that exclude them
- -Dividing by PGI when the market ratios are stated on EGI
- -Concluding that expenses are out of line before matching the basis
Concept Deep Dive
Analysis
This tests whether a candidate compares like with like when checking an expense ratio against market data. The survey excludes reserves and uses EGI, so the subject's numerator and denominator both have to match that basis. Once the $2,400 reserve is removed, the apparent high ratio disappears.
Background Knowledge
An expense ratio relates total expenses, excluding debt service, to potential or effective gross income. Market practice differs on whether a replacement allowance is deducted, so a ratio means little until its reserve treatment and income base are known. Recent subject history is a starting point that is checked against comparable data.
Real-World Application
An owner's bookkeeper lists a reserve deposit among the operating expenses of a small rental. A lender's reviewer questions the high expense ratio in the appraisal. The appraiser shows that with the reserve taken out, the ratio matches the market survey.
More Income Approach Questions
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Previous Question
An appraiser is extracting an overall capitalization rate from the sale of a 16-unit apartment building. The recorded price was $1,500,000, including favorable seller financing, and the cash equivalent price is $1,400,000. The broker reports NOI of $124,000. The owner managed the property, and the statement shows no management charge; management of similar properties costs $12,000 per year. The appraiser's income estimate for the subject includes a market management expense. What overall capitalization rate is indicated?
Next Question
The subject property is a 12-unit apartment building with stabilized annual NOI of $108,000. An appraiser applies a 7.5% overall rate from sales of similar buildings. Those sales, and others in the market, also closed at $138,000 to $150,000 per unit. What should the appraiser do with the direct capitalization result?