The subject property is an owner-managed fourplex. Market rent at full occupancy is $72,000 per year, and there is no other income. The owner's actual vacancy and credit loss is 2%, while competing fourplexes show a stabilized loss of 6%. The owner's statement lists $21,000 of operating expenses, $18,000 of mortgage payments and no management cost. Competing fourplexes pay management fees of 5% of EGI, and the overall rate is 8%. What is the indicated market value?
Correct Answer
A) $541,200
Market EGI is $72,000 × 0.94 = $67,680 and market management is 5% of that, $3,384, so NOI is $67,680 − $21,000 − $3,384 = $43,296 and value is $43,296 ÷ 0.08 = $541,200. Mortgage payments are not an operating expense. Keeping the owner's 2% loss while charging management gives $575,400. Using the market loss but omitting management gives $583,500. Accepting the owner's vacancy and expenses as reported gives $619,500.
Why This Is the Correct Answer
Option A is correct because a typical purchaser would project the market 6% loss and a market management cost. EGI is $67,680, management is $3,384, NOI is $43,296, and $43,296 ÷ 0.08 = $541,200.
Why the Other Options Are Wrong
Option B: $575,400
Option B, $575,400, keeps the owner's 2% loss: EGI $70,560 less management $3,528 and expenses $21,000 is $46,032, and $46,032 ÷ 0.08 = $575,400. The market loss is 6%, which leads to NOI of $43,296 and $541,200.
Option C: $583,500
Option C, $583,500, leaves out management: ($67,680 − $21,000) ÷ 0.08 = $583,500. Owner-managed property still has a management cost, so $3,384 must be deducted to reach $541,200.
Option D: $619,500
Option D, $619,500, accepts the owner's vacancy and expenses as reported: ($70,560 − $21,000) ÷ 0.08 = $619,500. It misses both market corrections; with them NOI is $43,296 and value is $541,200.
Owner's books, market's model
Start from the owner's statement, then replace each line with what a typical buyer would expect. Unpaid management is still a cost.
How to use: Use this reminder whenever an operating statement comes from an owner who manages the property personally.
Exam Tip
When a percentage management fee is based on EGI, fix the vacancy line first. The fee changes when EGI changes.
Common Mistakes to Avoid
- -Accepting the owner's actual vacancy in a stabilized market model
- -Omitting management because no cash fee was paid
- -Deducting mortgage payments as an operating expense
Concept Deep Dive
Analysis
This item tests whether you can tell an owner's actual results from a stabilized market estimate. Two lines need correcting: the loss rate moves to the market's 6%, and a management charge is added even though the owner pays none. The mortgage payments stay out of NOI because they are a financing cost, and the management percentage applies to the corrected EGI.
Background Knowledge
A stabilized model estimates what a typical purchaser would project, which can differ from what the current owner reports. Unpaid owner labor is one common gap between an owner's statement and a market operating statement.
Real-World Application
An appraiser receives a clean statement from a retired owner who runs a fourplex personally and has long-term tenants. The appraiser adjusts vacancy, adds management and removes the mortgage payments so the NOI matches what competing fourplexes would report before applying a market rate.
More Income Approach Questions
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Previous Question
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?
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A client is considering the purchase of a fourplex listed at $675,000. Stabilized NOI is $42,000, and recent sales of similar fourplexes indicate an overall rate of 7.2%. What overall rate does the list price represent, and how does the list price compare with the value indicated at the market rate?