c. Gross income Explanation: Gross income is the amount of gross receipts if all available income is collected; it assumes no vacancies or collection losses. b. Economic (market) rent Explanation: Because a lease interest is not being valued, the market rent should be used to
estimate income. By using market rent (the typical rent found in comparable properties) instead of the actual rent of the property, the appraiser will be estimating the value to a typical investor, or market value. a. It would be included as "other income" in calculating gross income Explanation: Income from renting a garage space
is an example of "other income" that would normally be included in the calculation of gross income, because the garage is part of the apartment complex. d. The amount will vary with each property Explanation: There is no absolute number or adjustment that can be used for vacancy allowance. One of the responsibilities of the appraiser in analyzing the market is to estimate what the
specific number should be for the subject property. b. Gross income and vacancy and collection loss Explanation: By definition, effective gross income is equal to gross income less vacancy and collection loss. b. Mortgage payments Explanation: Mortgage (debt) payments are not part of the calculation
to estimate net operating income. The remaining three choices are all subtracted from effective gross income to estimate net operating income. b. Repair and maintenance Explanation: The appraiser needs to analyze all expenses carefully when using the income approach to value. One reason is
to make sure that certain items are not being either counted twice or eliminated completely. One area where careful attention should be given concerns replacement allowances, which could have mistakenly been placed in a repair and maintenance category. c. Expenses that do not vary with the level of occupancy Explanation: The distinction between fixed and variable expenses is based on whether or not the expense varies with the
level of occupancy. For example, property taxes are considered a fixed operating expense because they will not change if occupancy (vacancy) changes. However, they are not necessarily constant over a holding period and certainly not forever. b. Roof replacement when it is worn out Explanation: Reserves are intended for long-lived items that must be replaced before the end of the economic life of the property. An example would be the replacement of a
worn-out roof. "a." is replacing the entire building at the end of its remaining economic life; "b." is replacing the roof when it, the roof, is worn out, but before the building has reached the end of its economic life, so that it, the building, can continue to produce income. b. Gross lease Explanation: If the lessor has to pay the expenses, it is a gross lease. If the lessee (tenant) pays the expenses, it is a net lease. The term pass through is sometimes used to refer to passing through expenses to a
tenant. Estimate the annual gross income of the subject property based upon the following data: Neighborhood: All stores are 100 feet in depth; and, except for front footage, all of the stores are similar in age, quality, condition, and other units of comparability. The neighborhood has averaged 5 percent vacancy and collection losses over the last five years. Subject Property: The subject property has 50 feet of frontage. The building
was leased four years ago for $1,000 per month. The term of the lease is ten years. The subject's rental income is old. Three comparables, 1, 2, and 3B, provide the best evidence of current market rents. 3, 3C, and
3D, are old and/or long term leases, and not good indicators current market rents – for property tax appraisal purposes, we're usually after a fee simple absolute value, "free and clear" of any restrictions.
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ParcelGross IncomeFront FootagePrice per Front FeetSquare FootagePrice per Square FeetRemarks Subject
$1,000
50
$20.00
5,000
20¢
Old Lease; 10 Years
1
$1,200
40
$30.00
4,000
30¢
Recent Lease; 5 Years
2
$1,500
50
$30.00
5,000
30¢
Recent Lease; 5 Years
3
$3,000
160
$18.75
16,000
18¾¢
Old Lease; Larger; 25 Years
A
$1,300
40
$32.50
4,000
32½¢
Month to Month
B
$1,200
40
$30.00
4,000
30¢
One Year Old Lease; 5 Years
C
$1,000
40
$25.00
4,000
25¢
Old Lease; 5 Years
D
$1,100
40
$27.50
4,000
27½¢
10 Year Lease
Gross Income: 50 F.F. x $30.00/F.F. = $1,500 x 12 months = $18,000
- Determine the Net Income Before Recapture [NIBR] for a duplex renting for $850 each side. The tenant pays the utilities only. The owner pays $50/mo. for water, sewer, and garbage for the building, insurance is $700 per year; taxes are based on a $175,000 value with a 1% tax rate; and maintenance is $70/mo. each side. Both units have been occupied for several years; it is appropriate to make no adjustment for vacancies and collection losses.
Solution:
Gross Income (GI) : $850 x 2 units x 12 months
$20,400
Effective Gross Income [EffGI]
$20,400
Water/sewer/garbage: $50 x 12 months
-
$600
Maintenance: $70 x 2 units x 12 months
-
$1,680
Net Income Before deducting Recapture & Taxes (NIBT)
=
$17,420
Property Taxes (PT): $175,000 x 1%
-
$1,750
Net Income Before Recapture (NIBR)
=
$15,670
- Determine the Net Income Before deducting for Recapture [NIBR] for a 40,000 sq. ft. warehouse that rents for $0.35 per sq. ft. / mo. The insurance cost is $0.11 per sq. ft./year; maintenance costs and reserves for replacement is $0.40 per year; water and sewer cost is $150/mo.; garbage cost is $200/mo.; and taxes are based on a value of $1,500,000, with a tax rate of 1%. Vacancies and collection losses are 7%.
Solution:
Gross Income (GI): 40,000 x $0.35 x 12
$168,000
Vacancy & Collection Loss (V&CL): $168,000 x 7%
-
$11,760
Effective Gross Income (EGI)
=
$156,240
Insurance: 40,000 x $0.11
-
$4,400
Maintenance and reserves: 40,000 x $0.40
-
$16,000
Water/sewer/garbage: $350 x 12
-
$4,200
Net Income Before deducting Recapture & Taxes (NIBT)
=
$131,640
Property Taxes (PT): $1,500,000 x 1%
-
$15,000
Net Income Before Recapture (NIBR)
=
$116,640
- Determine the Net Income Before deducting for Recapture [NIBR] for a 60,000 sq. ft. office building that rents for $1.85 sq. ft. / mo. The expenses are as follows: vacancy 7%; insurance $10,800; management 7% of effective gross income; maintenance $28,800; utilities $108,000, janitorial $43,200; and property taxes based on a value of $9,000,000 with a rate of 1%.
Solution:
Gross Income (GI): 60,000 x $1.85 x 12
$1,332,000
Vacancy & Collection Loss (V&CL): $1,332,000 x 7%
-
$93,240
Effective Gross Income (EGI)
=
$1,238,760
Management: $1,238,760 x 7%
-
$86,713
Net Income Before deducting Recapture and Taxes (NIBT)
=
$961,247
Property Taxes (PT): $9,000,000 x 1%
-
$90,000
Net Income Before Recapture (NIBR)
=
$871,247
- Determine the Net Income Before deducting for Recapture [NIBR] for a 30,000 sq. ft. retail store that rents for $0.70 sq. ft. / mo. on a net rent to the owner. Vacancy and collection loss are estimated at 3.5%. The only expenses to the owner are a 1% management cost and a pro rata share on the vacant area that amounts to $700/mo.
Solution:
Gross Income (GI) = 30,000 x $0.70 x 12
=
$252,000
Vacancy & Collection Loss (V&CL) = $252,000 x 3.5%
-
$8,820
Effective Gross Income (EGI)
=
$243,180
Management = $243,180 x 1%
-
$2,432
Expenses = $700 x 12
-
$8,400
Net Income Before deducting Recapture (NIBR)
=
$232,348
Rent is net to the owner; therefore, the owner passes through all operating expenses, including property taxes, to the tenant. Even though it is a "net" lease, it is appropriate to deduct for V&CL, if vacancies and/or collections losses are typical in the market. Note that the Net Income Before deducting Recapture is the same net income level as Net Operating Income [NOI] – two names, but the same level of net income -- annual net income after all operating expenses, including ad valorem property taxes are subtracted from the effective gross income.
- Using the actual income statement provided, determine the Net Income Before deducting Recapture [NIBR] for an apartment complex with eight 2-bedroom units renting for $650 per unit. The market vacancy and collection loss is 5%. The building manager has supplied you with a statement of income and expenses for the past year. This statement, prepared by his accountant, shows actual dollars received and spent.
Income and Expense Statement
- Actual Rents Received$ 58,000
- Expenses45,356
- Corporate Franchise Tax$8,700
- Depreciation8,000
- Insurance1,800
- Interest on Mortgage5,000
- Manager's Salary2,166
- Miscellaneous Repairs2,500
- Real Estate Property Taxes9,000
- Reserve for Replacement1,190
- Scheduled Maintenance3,600
- Utilities3,400
- Net Annual Profit$ 12,644
Solution:
Effective Gross Income (EGI)
$58,000
Property Management
-
$2,166
Property Insurance
-
$1,800
Reserve for Replacement
-
$1,190
Net Income Before deducting Recapture and Taxes (NIBT)
=
$43,344
Property Taxes (PT)
-
$9,000
Net Income Before Recapture (NIBR)
=
$34,344
Notice that in exercise above, the income did not begin with gross income instead the income stream was processed using effective gross income. As discussed in the lesson, effective gross income is the amount of income that remains after deducting vacancy and collection loss. The actual rents received are the effective gross income of the property. Since we have the effective gross income of the property, we do not need to deduct for vacancy and collection losses. In addition, the expenses also require analysis: corporate franchise tax, depreciation, and mortgage interest are excluded from the definition of gross outgo and, therefore, are not deducted as operating expenses.
(1) Using the property's actual Income and Expense Statement below for this year, process the gross income to the actual Net Income Before deducting for Recapture AND property Taxes [NIBT]. (2) Would this be the same NIBT you would use to value the property; if not, what would you use?
The owner of a 25-year-old apartment building has supplied you with this statement of income and expenses for the past year. The statement, prepared by his accountant, shows actual dollars received and spent. The building contains 15 units, of which eight are studio apartments that rent for $300 per month; five are one bedroom units at $360 per month; and two are three-bedroom units at $540 per month. The rental schedule is well in line with other apartments in the neighborhood. A 5 percent vacancy and collection loss factor is reasonable for the area. The cost to replace the building today is $540,000.
Income and Expense Statement
- Actual Rents Received$ 57,520
- Expenses:42,744
- Supplies$ 660
- Roof Repair1,000
- Water1,000
- Corporation Franchise Tax2,000
- Janitor's Salary3,000
- Miscellaneous Repairs3,130
- Insurance (3-year Premium)3,600
- Manager's Salarty3,600
- Electricity3,700
- Real Estate Property Taxes4,136
- Interest on Mortgage4,548
- Gas6,200
- Depreciation8,000
- Net Annual Profit$ 14,776
Solution:
Part 1: Compute NIBT
Actual Effective Gross Income (EGI)
$57,520
Actual Allowable Operating Expenses (OE)
Miscellaneous Repairs
$3,130
Insurance ($3,600/3 Years)
$1,200
Actual Net Income Before deducting Recapture and Taxes (NIBT)
=
$34,030
Part 2: Would you use NIBT from Part I to value the property?
You would not use the NIBT that was calculated in part I because it was based on actual income and expenses for the property. For purposing of deriving value, we use market rents and expenses. If the income was being processed for valuation purposes, the income would be processed as follows:
Gross Income:
- 8 units x $300 x 12 months$ 28,800
- 5 units x $360 x 12 months$ 21,600
- 2 units x $540 x 12 months$ 12,960
$63,360
Potential Gross Income (PGI)
$63,360
Vacancy & Collection Loss (V&CL) = $63,360 x 5%
-
$3,168
Effective Gross Income (EGI)
=
$60,192
Operating Expenses (OE) = $60,192 x 25%
-
$15,048
Net Income Before deducting Recapture & Taxes (NIBT)
=
$45,144
(Note in this case the gross income was based on the properties actual rent schedule – that was because it was representative of market – the situation explained that the rent schedule is well in line with other apartments in the neighborhood.)