An appraiser extracted an overall rate from sales of similar office buildings, and the income from those sales had no deduction for recurring leasing commissions. The subject office building is at stabilized occupancy, and its owner's budget shows $8,000 a year for recurring leasing commissions. In direct capitalization at the extracted rate, how should the appraiser treat the $8,000?
Correct Answer
A) Make no deduction from the income capitalized
When a rate comes from sales with no deduction for recurring leasing expenses, the effect of those expenses is already in the rate, so no deduction is made from the subject's income. Deducting the $8,000 would count the cost twice, and also raising the rate would add a further overlap. The amount is a recurring cost at stabilized occupancy, not an initial lease-up cost to be subtracted from value.
Why This Is the Correct Answer
Option A is correct because the rate came from sales with no deduction for recurring leasing expenses, so the impact of those costs is already reflected in the rate. Income capitalized at that rate should be on the same basis. The subject's NOI therefore takes no deduction for the $8,000.
Why the Other Options Are Wrong
Option B: Deduct the $8,000 from net operating income
Option B deducts the $8,000 from net operating income. Recurring commissions are a real cost, but this rate already reflects them, so also deducting them from NOI would count the cost twice.
Option C: Deduct the $8,000 and increase the overall rate
Option C deducts the $8,000 and increases the overall rate. No fact points to a higher rate, and doing both layers two more effects onto a cost that the market-derived rate already reflects.
Option D: Subtract the $8,000 from the indicated value
Option D subtracts the $8,000 from the indicated value, as if it were a one-time initial lease-up cost. These are recurring commissions at stabilized occupancy, and initial lease-up costs are a different item, so this treatment does not fit.
Left out there, left out here
If a cost was left out of the comparable's income when the rate was derived, leave it out of the subject's income too. The rate has already priced it.
How to use: Use this phrase whenever you know how a rate treated a particular cost.
Exam Tip
Before deducting an unusual expense, check how the rate's source sales treated it. The treatment on both sides should match.
Common Mistakes to Avoid
- -Deducting recurring leasing costs from income when the rate already reflects them
- -Confusing recurring leasing costs with initial lease-up costs
- -Assuming a cost must be deducted because it appears in the owner's budget
Concept Deep Dive
Analysis
This is a consistency judgment. A market rate carries whatever costs were left out of the income it was derived from, so the first step is to see how the sales behind the rate treated leasing costs. Since they were not deducted there, deducting them from the subject would count the same cost twice.
Background Knowledge
Recurring leasing expenses arise from tenant turnover after stabilized occupancy. In direct capitalization they are sometimes annualized, but more frequently no deduction is made, and the effect is then reflected in the rate. In discounted cash flow analysis, expected leasing costs are typically deducted when they are forecast to occur.
Real-World Application
An appraiser values a stabilized office building using rates from sales analyzed before leasing costs. The owner's budget includes annual commissions, but the appraiser leaves them out of the capitalized income and explains why in the report.
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Previous Question
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?
Next Question
The subject property has annual PGI of $112,000, combined vacancy and collection loss of 5% and no other income. Property expenses are $18,000, and an annualized leasing-cost allowance, not included in that figure, is $7,000. The 10% capitalization rate was derived from income stated after the same allowance. What value is indicated?