A property has annual potential base rent of $92,000 and additional potential percentage rent of $8,000. Combined vacancy and collection loss is 5% of their total, and all property expenses are $17,000. No other deductions apply. Using a 10% overall rate, what value is indicated?
Correct Answer
B) $780,000
((92000+8000)×0.95−17000)÷0.10 = 780000. Common errors: capitalizing EGI instead of NOI gives $950,000; leaving out the percentage rent gives $704,000; not deducting the 5% loss gives $830,000.
Why This Is the Correct Answer
Option B is correct because potential income is $92,000 + $8,000 = $100,000, EGI is $100,000 × 0.95 = $95,000, NOI is $95,000 − $17,000 = $78,000, and value is $78,000 ÷ 0.10 = $780,000.
Why the Other Options Are Wrong
Option A: $704,000
Option A, $704,000, comes from leaving out the percentage rent: ($92,000 × 0.95 − $17,000) ÷ 0.10 = $704,000. Including the $8,000 gives (($92,000 + $8,000) × 0.95 − $17,000) ÷ 0.10 = $780,000.
Option C: $830,000
Option C, $830,000, results from skipping the 5% loss: ($92,000 + $8,000 − $17,000) ÷ 0.10 = $830,000. Deducting the loss first gives ($95,000 − $17,000) ÷ 0.10 = $780,000.
Option D: $950,000
Option D, $950,000, comes from capitalizing EGI instead of NOI: ($92,000 + $8,000) × 0.95 ÷ 0.10 = $950,000. Deducting the $17,000 of expenses gives $78,000 ÷ 0.10 = $780,000.
PGI, EGI, NOI, then value
Climb the ladder in order: potential income, less loss, less expenses, then divide by the rate.
How to use: Use this sequence on any multi-step direct capitalization problem.
Exam Tip
Write each intermediate figure (PGI, EGI, NOI) so you can see which step a wrong answer skipped.
Common Mistakes to Avoid
- -Omitting percentage rent from potential income
- -Skipping the vacancy and collection loss
- -Capitalizing EGI instead of NOI
Concept Deep Dive
Analysis
This question tests the full income ladder: combine base and percentage rent into potential income, deduct the 5% loss to get EGI, subtract expenses for NOI, then capitalize at 10%. Each step must be done in order.
Background Knowledge
Percentage rent, also called overage rent, is paid above the base rent and forms part of potential gross income. Vacancy and collection loss is deducted to reach EGI, operating expenses are deducted to reach NOI, and NOI is capitalized to value. Each step builds on the one before it.
Real-World Application
An appraiser valuing a retail property finds a tenant pays base rent plus a percentage of sales above a breakpoint. The appraiser includes supported percentage rent in potential income, applies a market vacancy and collection allowance, deducts expenses and capitalizes the NOI.
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?
In the subject's market, lenders on fourplexes have lowered their typical loan-to-value ratio from 70% to 60%. The annual mortgage constant remains 5% and the equity dividend rate remains 10%. The subject's NOI has not changed. How does this affect the overall rate indicated by the band of investment and the indicated value?
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Previous Question
The subject property is a 50-year-old rental house with market rent of $2,300 per month. The only recent sales of rental houses in the market area involve houses built within the past 10 years, which rent for about the same amount and indicate a monthly gross rent multiplier of 210. How is applying 210 to the subject's rent most likely to affect the value indication?
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Market evidence supports higher risk and weaker income-growth prospects at a future sale than at acquisition, all else equal. What can justify a higher terminal cap rate?