Which pair belongs on a reconstructed operating statement, properly classified?
Correct Answer
B) Property tax as fixed; snow removal as variable
Why this is correct: In a reconstructed operating statement, property tax is a fixed expense (doesn't vary with occupancy), while snow removal is a variable expense (can vary with use and weather). Why the other choices are wrong: Depreciation as fixed; principal as variable is wrong because depreciation and principal are not operating expenses. Income tax as variable; points as fixed is incorrect; income tax is non-operating, and points are financing costs. Loan interest as fixed; capital additions as reserves is wrong; interest is non-operating, and capital additions are not reserves. Exam tip: Only operating expenses belong in NOI; exclude financing, depreciation, and income taxes.
Why This Is the Correct Answer
Property tax continues regardless of occupancy and is a fixed operating expense, while snow removal varies with weather and use and is a variable expense.
Why the Other Options Are Wrong
Option A: Depreciation as fixed; principal as variable
Accounting depreciation and loan principal are both excluded from a reconstructed statement entirely.
Option C: Income tax as variable; points as fixed
Income tax and loan points are ownership and financing items excluded from the statement.
Option D: Loan interest as fixed; capital additions as reserves
Loan interest is a financing item that is excluded, and capital additions are excluded rather than reclassified as reserves.
Property Expenses In, Owner Expenses Out
Property Expenses In, Owner Expenses Out. Debt, taxes on income and depreciation belong to the owner, not the building.
How to use: Test each line: would a different owner with different financing still incur it? If not, it comes out.
Exam Tip
Reserves are a third category alongside fixed and variable, and their treatment must match the capitalization rate's derivation.
Common Mistakes to Avoid
- -Leaving debt service or depreciation in the statement
- -Classifying capital additions as operating expenses
- -Treating reserves inconsistently with the capitalization rate
Concept Deep Dive
Analysis
A reconstructed operating statement restates an owner's accounting into the form the income approach requires, and the classification rules are strict about what belongs and where. Operating expenses divide into fixed — those that continue regardless of occupancy, such as property taxes and insurance — and variable, those moving with occupancy and use, such as utilities, management, maintenance and snow removal. Reserves for replacement are a third category, an annual allowance for short-lived component replacement. What must come out of the statement entirely are items belonging to the owner rather than the property: debt service and loan interest, income taxes, loan points, depreciation as an accounting entry, and capital additions. Excluding them is what allows the resulting net operating income to be compared across properties with different ownership and financing, and what makes a capitalization rate extracted from one sale applicable to another.
Background Knowledge
A reconstructed operating statement classifies fixed and variable operating expenses and reserves for replacement, excluding debt service, income taxes, accounting depreciation and capital additions so that net operating income is comparable across properties.
Real-World Application
An appraiser reconstructs an owner's statement, removing mortgage interest and depreciation, and classifying taxes as fixed and maintenance as variable.
More Income Approach Questions
In a percentage lease, rent is commonly structured as:
In a DCF, what is the reversion?
Potential gross income differs from effective gross income in that PGI assumes:
The reversion in a discounted cash flow model represents:
Building A (new, credit tenant, 20-year lease) and Building B (older, month-to-month tenants) sell the same week. Their cap rates should differ how?
An overall rate extracted from a sale whose NOI excluded reserves, applied to a subject NOI that includes them, will:
Replacement reserves cover which kind of expenditure?
What is the primary distinction, for appraisal purposes, between 'vacancy loss' and 'collection loss'?
An appraiser is analyzing a mixed-use property with retail and office components. The retail segment has a potential gross income of $180,000 with a market vacancy of 8%. The office segment has a potential gross income of $120,000 with a market vacancy of 12%. What is the overall effective gross income for the property?
The mortgage constant represents:
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Previous Question
An appraiser is valuing a retail plaza subject to a 20-year triple net lease with 12 years remaining. The contract rent is $24 per square foot annually, while current market rent for comparable space is $18 per square foot. The leased fee interest is being appraised for estate tax purposes. Which statement is correct regarding the income approach?
Next Question
A medical office building is leased to a physician group under a 12-year lease with rent set at $24.00/sf/year, escalating 3% annually. Market rent for similar space is currently $26.50/sf/year and is projected to grow at 2.75% annually. The appraiser calculates the present value of the rent differential (market minus contract) over the lease term at a 7.5% discount rate and arrives at $1,024,000. What does this figure represent?