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6.3
Income Methods
MATH

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 6.3 Income Method MATH
3). INCOME / INVESTMENT METHOD
Income producing properties (Rental, Commercial)

Life of building is based on economic factors, so No depreciation is used!

Value of Commercial property:

***Appraiser looks at:

Ø Current leases
Ø Registered Mortgages Warehouses, leasehold
Ø Physical characteristics of building interests, apartment
Ø BUT NOT the expected rent/expense forecast predicted by the BUYER buildings, NOT single-family
residences
Investors are interested in the % - yield expected to earn

LEASE CONSIDERATIONS “Net” Leases

tenant pays base rent +
From WORST to BEST for the Landlord:
their share of operating
• “Gross Lease” - tenant pays a constant rent amount, owner pays ALL operating expenses
expenses (security to tenant)
o IF used for commercial, typically includes an Escalator clause Escalator Clause
• “Single net” - tenant pays a base rent + share of the operating expenses (taxes,
allows the landlord to
utilities, heating, R&M, etc.)
• “Triple Net” - tenant pays base rent + all operating expenses (but no structural
recover any increases
repairs) in the cost of an
• “Absolute Net” - tenant pays base rent + all operating expenses + structural repairs expense over a stated
base

EQUITY means the

Yield % = NOI (Net Operating Income) Sale Price = NOI (Net Operation Income) total value of all
Sale Price Capitalization Yield % property minus all
mortgage debts
Gross Potential Fill in the boxes
GROSS POTENTIAL REVENUE
– VACANCY & BAD DEBT* – Gross Realized
= GROSS REALIZED REVENUE**
– –
– EXPENSES
= NET OPERATING INCOME = Net operation Income NOI = Net Operation Income NOI

Capitalization Yield of Multiple Properties

Capitalization Yield = (1st % +2nd %) ÷ 2
Example:

an average yield of all

Buildings being compared

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 6.3 Income Method MATH
Gross Potential Revenue NET OPERATING INCOME (NOI)

• The potential rents (not current rents) earned if • Represents a return on the entire value of the property
the building has 100% occupancy • Not a return on the equity portion
• Cannot include Leasing fees (advertising, com %)

“Other Revenue” (income) *Bad Debt = Collection Loss

**Gross Realized Revenue
• Garage rental, laundry income
= Effective Gross Income (EGI)

Appraisers estimate
market value (NOT
value-to-owner)

Items Omitted in Calculating NOI

“NOT INCLUDED because they are specific to the
individual owner or investor:

• Income tax
• CCA - Capital Cost Allowance
• Debt Service (Debt repayments)
• Depreciation - cannot use to calculate NOI!!!
o remember: economic durability matters!
(vs. physical durability)

EXPENSES
FIXED EXPENSES - must be paid regardless of use Cyclical Repairs
repairs that are done on a periodic basis, an appropriate
Ø Real Property Taxes - largest operating expense (not income
annual allowance should be made to cover the total
taxes!)
periodic cost.
Ø Insurance Policies

REPLACEMENT RESERVES
VARIABLE EXPENSES
“an annual sum set aside for replacement,
Ø Management (not leasing inducement) repairs, and renovations”
Ø Utilities (electricity, gas, water, sewer) Provides for a periodic replacement of building
Ø Maintenance and repairs - cyclical components that wear out more rapidly than the
Ø Cleaning/janitorial, Garbage removal building itself
Ø Grounds and parking area maintenance
It replaces equipment with relatively short lives such as
Ø Wages
stoves, refrigerators, washing machines, carpeting
Ø Decorating
Ø Replacement reserves
Ø Misc: advertising, licensing, janitor supplies
One time Expenses
Ø Immediate repairs - deducted as a lump sum of final value
one-time payment repairs that are immediately required at
Interest on the mortgage or mortgage payments or leasing the time of appraisal should be deducted as a lump sum
fees: Cannot be used as an expense! from the property’s final value.

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 6.3 Income Method MATH

Questions
23). The investment method of appraisal is generally used for the:

(1) Properties that produce rental income

(2) Single family homes
(3) Air space rights
(4) Properties that possess latent value

24). A property listed for sale has a net operating income of $15,763 per annum that is assumed to be perpetual and
constant. The market capitalization rate is 9.5% per annum. What is the maximum price a prudent investor should
pay for this property?

(1) $149,748.50
(2) $165,926.32
(3) $132,667.49
(4) $172,389.33

25). A property recently sold for $800,000. The stabilized annual net operating income for the property is $88,000. The
yield on this property is:

(1) 11%
(2) 9%
(3) 12%
(4) 14%

26). In appraising a residential apartment building, you used a market determined capitalization rate of 6.10% to
estimate a market value of $10,200,000. If a more appropriate capitalization rate turned out to be 5.13%, then the
market value (sale price) rounded to the nearest $1,000 would be:

(1) $12,129,000
(2) $11,222,000
(3) $10,568,000
(4) $10,129,000

27). TRUE OR FALSE? Gross potential revenue is estimated using the rents currently earned by the property.

(1) TRUE
(2) FALSE

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 6.3 Income Method MATH
28). TRUE OR FALSE? Potential revenue from laundry machines is not considered to be “other income” because it is
difficult to estimate the amount of laundry tenants will do in a year.

(1) TRUE
(2) FALSE

29). Which of the following statements regarding the income approach is FALSE?

(1) Items specific to an owner or investor are omitted in the calculation of net operating income.
(2) Net operating income considers deprecation, income tax, and debt service.
(3) Leasing fees incurred by the landlord are not considered an operating expense.
(4) The cost of repairs that are considered a one-time payment and are immediately required at the time of
appraisal should be deducted as a lump sum from the property’s final value.

30). TRUE OR FALSE? A wide gap may exist between gross potential revenue and gross effective revenue of an
apartment building if the property is managed poorly.

(1) TRUE
(2) FALSE

31). Which of the following describes a Replacement Reserve?

(1) It is a special fund to be used for emergency only

(2) It’s an annual sum set aside for replacement, repairs and renovations
(3) It’s a schedule of anticipated costs for replacement of equipment and appliances, excluding major roof repairs
and renovations
(4) It’s a stock of monthly supplies which are to be periodically replaced

Answers: 23(1), 24(2), 25(1), 26(1), 27(2), 28(2) 29(2), 30(1), 31(2)

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 6.3 Income Method MATH

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