The subject property is a fourplex with six detached garages that are rented separately. Potential rent from the apartments is $72,000 a year, with stabilized vacancy and credit loss of 5%. Potential garage rent is $7,200 a year, and similar garages in the area experience 25% vacancy and credit loss. Annual operating expenses are $25,800, and the market overall rate is 8%. What is the indicated value by direct capitalization?
Correct Answer
A) $600,000
Each income source takes its own loss: apartment rent becomes $72,000 × 0.95 = $68,400 and garage rent becomes $7,200 × 0.75 = $5,400, so EGI is $73,800. NOI is $73,800 − $25,800 = $48,000, and $48,000 ÷ 0.08 = $600,000. $618,000 applies 5% to both sources, $622,500 leaves garage rent at its full potential, and $645,000 skips the loss on apartment rent.
Why This Is the Correct Answer
Option A is correct because each source takes its own loss: $72,000 × 0.95 = $68,400 for apartments and $7,200 × 0.75 = $5,400 for garages. EGI of $73,800 less expenses of $25,800 gives NOI of $48,000. Dividing by 0.08 indicates $600,000.
Why the Other Options Are Wrong
Option B: $618,000
Option B, $618,000, applies the 5% apartment loss to both sources: $79,200 × 0.95 = $75,240, − $25,800 = $49,440, ÷ 0.08. Garages have their own 25% loss, so EGI is $73,800 and the value is $600,000.
Option C: $622,500
Option C, $622,500, deducts the loss on apartments but counts garages at the full $7,200: $68,400 + $7,200 = $75,600, − $25,800 = $49,800, ÷ 0.08. The $7,200 is potential income that carries a 25% loss, which leads to $600,000.
Option D: $645,000
Option D, $645,000, takes the garage loss but not the apartment loss: $72,000 + $5,400 = $77,400, − $25,800 = $51,600, ÷ 0.08. Apartment rent also carries a 5% loss, so it should be $68,400 and the value $600,000.
Each income stream, its own loss
Picture two separate columns, apartments and garages. Take each column's loss before you add them together into EGI.
How to use: Use the two-column picture whenever a second loss rate appears.
Exam Tip
Check whether other income is stated as potential or as already collected. Potential income still needs a loss; collected income does not.
Common Mistakes to Avoid
- -Applying one loss percentage to total income when the rates differ
- -Counting potential other income as if it were fully collected
- -Taking the other-income loss and forgetting the rent loss
Concept Deep Dive
Analysis
There are two income sources with two different loss rates, so a single percentage on the total will not work. The skill is to reduce each source by its own rate, add the results to reach EGI, and only then deduct expenses. Garage rent is included because the garages are part of the real property.
Background Knowledge
Effective gross income can include non-rental income attributable to the real property, such as parking or garage income. Different income sources can have different occupancy and collection patterns. An estimate is more accurate when each source is reduced at the rate that fits that source.
Real-World Application
A fourplex's apartments stay nearly full, but its detached garages are rarely more than three-quarters rented. The appraiser estimates each source separately rather than applying the apartment vacancy rate to the garage income, which would overstate EGI.
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?
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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?
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Annual principal and interest debt service is $28,800 on an original mortgage principal of $360,000. What annual mortgage constant is annual debt service ÷ original principal?
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A broker tells an appraiser that fourplexes in the market area are selling at 12.5 times NOI. A lender’s survey of the same market reports a 7.5% overall rate. What overall rate does the broker’s figure represent, and how does its value indication compare with that of the lender’s rate?