The subject property is a 50-unit apartment building with 40,000 rentable and 44,000 gross square feet. Potential rent is $400,000 with 8% vacancy and collection loss. Expenses are property taxes of $30,000 a year, insurance of $0.50 per rentable square foot a year, maintenance of $600 per unit a year, a trash contract of $900 per month and management at 5% of effective gross income. The overall rate is 8%. What is the indicated value by direct capitalization?
Correct Answer
C) $3,235,000
EGI = $400,000 × 0.92 = $368,000. Expenses are $30,000 + $20,000 (40,000 × $0.50) + $30,000 (50 × $600) + $10,800 (12 × $900) + $18,400 (5% of EGI) = $109,200, so NOI = $258,800 and $258,800 ÷ 0.08 = $3,235,000. Using gross area for insurance gives $3,210,000, taking management on potential rent gives $3,215,000, and counting the trash contract as one month gives $3,358,750.
Why This Is the Correct Answer
Option C is correct because each line is converted to annual dollars on its stated basis. EGI is $400,000 × 0.92 = $368,000, and expenses are $30,000 + $20,000 + $30,000 + $10,800 + $18,400 = $109,200. NOI is $258,800, and $258,800 ÷ 0.08 = $3,235,000.
Why the Other Options Are Wrong
Option A: $3,210,000
Option A, $3,210,000, multiplies the insurance rate by 44,000 gross square feet, giving $22,000 and NOI of $256,800; $256,800 ÷ 0.08 = $3,210,000. The rate is per rentable square foot, so insurance is $20,000 and the value is $3,235,000.
Option B: $3,215,000
Option B, $3,215,000, takes the 5% fee on potential rent, giving $20,000 and NOI of $257,200; $257,200 ÷ 0.08 = $3,215,000. The fee is based on effective gross income, so it is $18,400 and the value is $3,235,000.
Option D: $3,358,750
Option D, $3,358,750, deducts one $900 month of the trash contract rather than 12 months, giving NOI of $268,700; $268,700 ÷ 0.08 = $3,358,750. The annual cost is $10,800, which gives $3,235,000.
Rate times its own base
Each rate has a base: rentable feet, units, months or EGI. Multiply each rate by its own base, and only then add.
How to use: Use this when an expense list mixes units of measure.
Exam Tip
When two areas or both monthly and annual figures appear, check which one each rate uses. Underline the unit attached to each rate before calculating.
Common Mistakes to Avoid
- -Applying a per-rentable-foot rate to gross area
- -Taking a percentage fee on potential rent when it is stated on effective gross income
- -Treating a monthly contract as an annual amount
Concept Deep Dive
Analysis
Each expense is stated on a different basis, and the skill is converting each line to an annual dollar amount using the correct quantity. Two areas are given, so you must notice which one the insurance rate uses. Management depends on EGI, so EGI must be calculated first.
Background Knowledge
Operating expenses can be estimated as lump sums, per square foot, per unit or as a percentage of effective gross income. Market data often come in these different forms, so an appraiser must convert them to a common annual basis. Careful labeling prevents errors of area or period.
Real-World Application
An appraiser builds a pro forma from a mix of data: an insurance quote per rentable foot, maintenance surveys per unit and a monthly trash invoice. Converting each to an annual amount lets the appraiser compare total expenses with competing buildings.
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 20-unit apartment building being appraised in fee simple. Sales of similar properties indicate a gross income multiplier of 8.5. The current rent roll, at below-market rents, shows potential gross income of $200,000. The appraiser's rent survey indicates market potential gross income of $240,000. A prospective buyer's pro forma shows potential gross income of $260,000. What is the indicated market value?
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