An appraiser is estimating the replacement allowance for a warehouse with effective gross income of $190,000 and other expenses, including property taxes, of $80,000. The short-lived components are roof covering costing $48,000 with a 20-year life, HVAC equipment costing $60,000 with a 15-year life, and paving costing $30,000 with a 10-year life. What is the net operating income after a straight-line replacement allowance?
Correct Answer
A) $100,600
Each component is annualized over its own life: $48,000 ÷ 20 = $2,400, $60,000 ÷ 15 = $4,000 and $30,000 ÷ 10 = $3,000, for a $9,400 allowance. NOI = $190,000 − $80,000 − $9,400 = $100,600. Dividing the $138,000 total by the 15-year average life gives $100,800, dividing it by the longest life gives $103,100, and omitting the allowance gives $110,000.
Why This Is the Correct Answer
Option A is correct because each component is annualized over its own life: $2,400 for the roof, $4,000 for HVAC and $3,000 for paving, totaling $9,400. NOI is $190,000 − $80,000 − $9,400 = $100,600. The method matches each cost to how often it recurs.
Why the Other Options Are Wrong
Option B: $100,800
Option B, $100,800, divides the $138,000 total by a simple average life of 15 years: $138,000 ÷ 15 = $9,200, leaving $110,000 − $9,200 = $100,800. A simple average ignores which costs attach to which lives; the component total of $9,400 leaves $100,600.
Option C: $103,100
Option C, $103,100, divides the $138,000 total by the longest life of 20 years: $138,000 ÷ 20 = $6,900, leaving $110,000 − $6,900 = $103,100. HVAC and paving wear out sooner than the roof, so the correct allowance is $9,400 and NOI is $100,600.
Option D: $110,000
Option D, $110,000, leaves out the allowance: $190,000 − $80,000 = $110,000. The figure requested is NOI after a straight-line allowance, so $9,400 is deducted and NOI is $100,600.
Each part, its own clock
Each component has its own clock. Divide each cost by its own life, then add the annual amounts.
How to use: Use this when several components with different costs and lives are listed.
Exam Tip
Do not average lives when costs differ. Divide first and add afterward, and watch for answer choices that are close together.
Common Mistakes to Avoid
- -Dividing total component cost by a simple average life
- -Using the longest component life for all components
- -Leaving the allowance out when the assignment calls for income after reserves
Concept Deep Dive
Analysis
This tests how a replacement allowance is built rather than whether one applies. Components wear out at different speeds, and short-lived items cost more per year for each dollar spent. Annualizing each component separately reflects those differences, whereas one blended life does not.
Background Knowledge
A replacement allowance provides for short-lived components that must be replaced during an improvement's economic life, such as roof covering, paving and HVAC equipment. In direct capitalization the cost is annualized because only one year's income is capitalized. The allowance can be built up from component costs and lives.
Real-World Application
An appraiser estimating a warehouse reserve gets cost quotes for the roof, HVAC units and paving. A short schedule of cost and life for each component gives a supportable annual total that can be checked against allowances seen in comparable sales.
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Previous Question
The subject property is a single-tenant retail building under a lease with exactly three years remaining and no renewal option. NOI at the contract rent is $100,000, and NOI at market rent would be $120,000; the difference is all rent, on identical expense terms. Sales of similar buildings leased at market rent indicate an overall rate of 8%. The market discount rate for the rent shortfall is 10%, with each year's shortfall taken at the end of the year. What is the indicated value of the leased fee interest, to the nearest dollar?
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A client owns a rental house leased at its market rent of $2,800 per month and asks an appraiser to analyze a $25,000 kitchen remodel that would raise market rent to $2,950 per month. Similar rental houses, remodeled or not, sell at a monthly gross rent multiplier of 215. What is the indicated value as remodeled, net of the remodel cost?