Replacement reserves cover which kind of expenditure?
Correct Answer
C) Periodic replacement of short-lived components like roofs and HVAC
Replacement reserves provide for periodic replacement of components with shorter lives, such as roofs and HVAC equipment. Routine maintenance, owner income taxes and principal repayments have different purposes. Whether a reserve is deducted above or below NOI must match the model and extracted rate convention.
Why This Is the Correct Answer
Option C is correct because a replacement reserve sets aside funds for periodic replacement of capital items with shorter lives than the building, such as roofs and HVAC equipment. These are not routine maintenance items.
Why the Other Options Are Wrong
Option A: The daily janitorial, landscaping and routine grounds-keeping work orders
Option A, daily janitorial, landscaping and grounds-keeping, describes routine operating and maintenance expenses. Maintenance and repair does not include replacing significant components, which is what reserves cover.
Option B: The owner's annual income-tax bill
Option B, the owner's annual income-tax bill, is a personal or business tax of the owner, not a property operating expense or capital replacement item.
Option D: Loan principal repaid each month
Option D, loan principal repaid each month, is part of debt service tied to financing. It is not a provision for replacing building components.
Reserves replace, repairs maintain
Reserves fund replacing short-lived components; maintenance keeps existing ones working.
How to use: Use this contrast to sort expenses on a reconstructed operating statement.
Exam Tip
Separate operating expenses, capital reserves, debt service and owner income taxes; only the first two are property-level items.
Common Mistakes to Avoid
- -Treating routine repairs as replacement reserves
- -Deducting loan principal as an operating expense
- -Including owner income taxes in property expenses
Concept Deep Dive
Analysis
This question tests what a replacement reserve covers. Reserves provide for periodic replacement of short-lived capital components, which differs from routine maintenance, owner income taxes and loan principal.
Background Knowledge
A reserve for replacements covers periodic replacement of capital items such as HVAC, roofs and parking lots. Whether reserves are deducted above the NOI line must match how the overall rate was extracted.
Real-World Application
An appraiser reconstructing a fourplex's operating statement sees no roof or furnace reserve on the owner's books. Because comparable sales were analyzed with reserves deducted, the appraiser adds a reserve allowance for consistency.
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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