A model explicitly defines potential gross rental income at market rent. Which assumption distinguishes it from effective rental income?
Correct Answer
A) Full scheduled occupancy before vacancy and collection losses.
In this expressly market-rent potential model, full-occupancy scheduled rent precedes vacancy and collection deductions. Other PGI models can use contract rent when appropriate to the appraised interest. Expenses are deducted later; potential income is not simply current cash receipts.
Why This Is the Correct Answer
Option A is correct because potential gross income is the total income before deducting vacancy and collection losses or operating expenses, which assumes full scheduled occupancy. Effective gross income is potential gross income less those losses. That full-occupancy assumption is what distinguishes the two.
Why the Other Options Are Wrong
Option B: The property has already been sold at the forecast horizon.
Option B assumes the property has already been sold at the forecast horizon. A resale assumption relates to a reversion in a discounted cash flow, not to the difference between potential and effective income.
Option C: Operating expenses have already been deducted.
Option C says operating expenses have already been deducted. Potential gross income is measured before vacancy and collection losses and before operating expenses, so expenses have not been deducted.
Option D: Only currently paying occupied units are counted.
Option D counts only currently paying occupied units. That describes something closer to actual collections, not potential income, which assumes full scheduled occupancy.
Potential means full house
Potential gross income pictures all units rented and paying; effective gross income subtracts the empty and unpaid ones.
How to use: Use this to keep the steps from PGI to EGI to NOI in order.
Exam Tip
Remember the sequence: PGI minus vacancy and collection loss equals EGI, and EGI minus operating expenses equals NOI.
Common Mistakes to Avoid
- -Counting only occupied units in potential gross income
- -Deducting expenses before reaching effective gross income
- -Confusing a resale assumption with an income definition
Concept Deep Dive
Analysis
This question tests the difference between potential gross income and effective income. Potential gross income assumes full scheduled occupancy before vacancy and collection losses, while effective gross income is what remains after those losses. Expenses come later and are not part of either gross income figure.
Background Knowledge
The income approach typically moves from potential gross income, to effective gross income after vacancy and collection loss, to net operating income after expenses. Potential income can be based on market rent or contract rent depending on the interest appraised and the model used.
Real-World Application
For a fourplex, an appraiser multiplies market rent by all 4 units to get potential gross income. The appraiser then deducts a supported vacancy and collection allowance to reach effective gross income.
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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