Question

You have just completed the appraisal of an office building and have concluded that the market value of the property is $2,500,000. You expect potential gross income (PGI) in the first year of operations to be $450,000; vacancy and collection losses to be 11 percent of PGI; operating expenses to be 45 percent of effective gross income (EGI); and capital expenditures to be 5 percent of EGI. a. What is the EGI for the first year? b. Assume above-line treatment, what is the NOI for the first year? c. What is the implied going-in capitalization rate? d. What is the effective gross income multiplier (EGIM)?

Answer 1

(a)EFFECTIVE GROSS INCOME = POTENTIAL GROSS INCOME LESS LOSS FOR VACANCY AND COLLECTION LOSSES

= $ 450,000 (-) 49,500= $ 400,500

THEREFORE EFFECTIVE GROSS INCOME FOR YEAR 1 = $ 400,500

NET OPERATING INCOME = EFFECTIVE GROSS INCOME LESS OPERATING EXPENSES

(b)HERE EFFECTIVE GROSS INCOME IS AS CALCULATED ABOVE ALREADY (I.E. $ 400,500)

OPERATING EXPENSES IS GIVEN AS 45% OF EFFECTIVE GROSS INCOME (I.E. 45% OF $ 400,500 =$ 180,225)

ASSUMING CAPITAL MAINTENANCE COST IS NOT INCLUDED , WE CAN ADD CAPITAL EXPENDITURE OF 5% OF EFFECTIVE GROSS INCOME (I.E. 5% OF $ 400,500= $ 20,025) TO THIS MAKING TOTAL OPERATING EXPENSE TO BE $ 200,250

THEREFORE NET OPERATING INCOME IS $ 400,500 (-) $ 200,250 = $ 200,250

IMPLIED GOING IN CAPITALISATION RATE = EXPECTED NET OPERATING INCOME / MARKET VALUE OF THE PROPERTY.

IN THIS CASE THE NET OPERATING INCOME IS $ 200/250 AND THE MARKET VALUE IS $ 2,500,000

(c)THEREFORE THE IMPLIED GOING IN CAPITALISATION RATE IS 200,250/2500000 = 8.01%

(d) EFFECTIVE GROSS INCOME MULTIPLIER IS ROUGHLY THE MARKET VALUE OF THE PROPERTY DIVIDED BY THE EFFECTIVE GROSS INCOME

IN THIS CASE 2500000/400,500= 6.24