An appraiser is estimating stabilized maintenance expense for a rental house. The owner's records show maintenance costs of $3,000 two years ago, $9,000 last year and $3,600 this year. Last year's figure includes $5,100 to clean up after a burst pipe; the cause was corrected, and no recurrence is expected. Maintenance costs on similar rental houses show no clear trend, and the appraiser concludes to the average annual recurring cost. What is the stabilized annual maintenance expense?
Correct Answer
B) $3,500
Only the $5,100 cleanup is non-recurring, so last year's recurring cost is $9,000 − $5,100 = $3,900, and the average of $3,000, $3,900 and $3,600 is $3,500. A plain average of the three recorded figures gives $5,200, which spreads a one-time cost into the forecast. Using this year's figure gives $3,600, and discarding last year altogether gives $3,300, which loses a year of valid recurring cost.
Why This Is the Correct Answer
Option B is correct because the $5,100 cleanup is the only non-recurring item. Last year's recurring cost is $9,000 − $5,100 = $3,900. The average of $3,000, $3,900 and $3,600 is $10,500 ÷ 3 = $3,500.
Why the Other Options Are Wrong
Option A: $3,300
Option A shows $3,300, the average of $3,000 and $3,600 with last year thrown out. That discards $3,900 of ordinary maintenance along with the cleanup; the correct average of all three recurring amounts is $3,500.
Option C: $3,600
Option C shows $3,600, this year's cost taken alone. With no clear trend in the market and an average as the conclusion, one year does not represent the history; the recurring average is ($3,000 + $3,900 + $3,600) ÷ 3 = $3,500.
Option D: $5,200
Option D shows $5,200, the plain average ($3,000 + $9,000 + $3,600) ÷ 3. It keeps the $5,100 cleanup in the history and so builds a cost that is not expected to recur into the forecast; the correct figure is $3,500.
Cut the spike, keep the year
Remove the one-time dollars from the unusual year, but keep that year's normal dollars in the history.
How to use: Use this when an expense history has one year far out of line with the others.
Exam Tip
Ask how much of an unusual figure has a stated one-time cause. The answer is often the remainder of that year, not the whole year and not zero.
Common Mistakes to Avoid
- -Averaging recorded costs without removing the one-time item
- -Throwing out a whole year because part of it was unusual
- -Treating the latest year as the forecast without testing it against the history
Concept Deep Dive
Analysis
This tests how to turn an uneven expense history into a forecast. The spike year is not all bad data: part of it is a one-time event and part of it is normal maintenance. The sound step is to remove the one-time amount, keep the recurring amount and then average the three recurring figures.
Background Knowledge
The income capitalized in direct capitalization is a forecast of what a prudent owner would expect, and it is not a simple projection of past results. Subject history is a starting point. Items that will not recur are removed so that the stabilized figure reflects ongoing operation.
Real-World Application
An appraiser receives three years of ledgers for a rental house and sees one year of unusually high repairs. Invoices show a single uninsured water loss that has been corrected. The appraiser backs out that invoice and bases the stabilized expense on the remaining amounts.
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Previous Question
Annual potential rental income is $250,000. Apply a 6% combined vacancy and collection loss to rent only. Other collectible real-estate income is already effective at $8,000, with no further loss. What total annual EGI results?
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An appraiser estimates annual EGI of $500,000 for an income property. Operating expenses, excluding debt service, are 36% of EGI, and the overall capitalization rate is 8%. What value is indicated?