chapter 18 bad debt Flashcards
Consider the following statements:
Vacancy and bad debt allowance is an allowance for reductions in gross potential revenue attributable to vacancies, tenant turnover, and non-payment of rent or other income.
When a property owner uses debt to finance a property, the net operating income represents a return on the equity portion of the property’s value.
Property taxes generally represent the single largest operating expense for an income-producing property.
The gross potential rent of the subject property is only estimated by the actual rents currently being paid on the subject property.
Which of the above statements is/are TRUE?
- C only
- A and C only
- B and D only
- A, B, and C only
Correct Answer: 2
Statement A is true; vacancy and bad debt allowance are not operating expenses, rather they indicate long term vacancy rates or trends in the area and are deducted from gross potential revenue property. Statement C is true; property taxes generally represent the single largest expense for income‑producing property. Statement B is false; net operating income represents a return on the entire value of the property, before financing is considered; net operating income is not a return on the equity portion of the property’s value. Statement D is false; the gross potential rent of the subject property is estimated by comparing current rental levels of comparable buildings, not the current rental level in the subject building. The rents of the subject property may be significantly more or less than the rents that the building would receive due to the poor management, the state of repair of the building or other factors. The appraiser must estimate the rent the building could receive by considering the rents received by several comparable buildings.
THE NEXT THREE (3) QUESTIONS ARE BASED ON THE FOLLOWING INFORMATION:
You are appraising a property using the income approach. You have gathered the following information regarding two comparable properties and the subject property. Long term vacancy and bad debt allowance rates for all buildings are expected to be 3%. Vacancy and bad debt allowance applies also to the parking and laundry revenue.
Subject Property
Patricia’s Place
Tommy’s Towers
Gross Potential Rent
$835,000
$860,000
$720,000
Other Income:
Potential Parking Revenue
11,600
10,200
9,400
Potential Laundry Revenue
4,700
5,300
4,100
Operating Expenses
252,000
255,000
243,000
Sale Price
?
7,900,000
8,250,000
The net operating income (rounded to the nearest dollar) for the subject property is:
- $542,139
- $573,761
- $597,568
- $583,600
Correct Answer: 2
Gross Potential Rent
$835,000
+ Potential Parking Revenue
11,600
+ Potential Laundry Revenue
4,700
= Gross Potential Revenue
$851,300
Less Vacancy/BD Allowance (3.0%)
(25,539)
= Effective Gross Income
$825,761
Less Operating Expenses
(252,000)
Net Operating Income
$573,761
You are appraising a property using the income approach. You have gathered the following information regarding two comparable properties and the subject property. Long term vacancy and bad debt allowance rates for all buildings are expected to be 3%. Vacancy and bad debt allowance applies also to the parking and laundry revenue.
Subject Property
Patricia’s Place
Tommy’s Towers
Gross Potential Rent
$835,000
$860,000
$720,000
Other Income:
Potential Parking Revenue
11,600
10,200
9,400
Potential Laundry Revenue
4,700
5,300
4,100
Operating Expenses
252,000
255,000
243,000
Sale Price
?
7,900,000
8,250,000
Assume that the appropriate market capitalization rate is 7.15% and that the appropriate net operating income of the subject property is $620,000. What is the value of the subject property rounded to the nearest $1,000?
- $87,000
- $8,000,000
- $8,671,000
- $4,433,000
Correct Answer: 3
Market Value = NOI ÷ Capitalization Rate = $620,000 ÷ 0.0715= $8,671,000.
You are appraising a property using the income approach. You have gathered the following information regarding two comparable properties and the subject property. Long term vacancy and bad debt allowance rates for all buildings are expected to be 3%. Vacancy and bad debt allowance applies also to the parking and laundry revenue.
Subject Property
Patricia’s Place
Tommy’s Towers
Gross Potential Rent
$835,000
$860,000
$720,000
Other Income:
Potential Parking Revenue
11,600
10,200
9,400
Potential Laundry Revenue
4,700
5,300
4,100
Operating Expenses
252,000
255,000
243,000
Sale Price
?
7,900,000
8,250,000
The yield of Tommy’s Towers and Patricia’s Place are:
- 6.71% and 8.23% respectively.
- 8.23% and 6.71% respectively.
- 5.68% and 7.52% respectively.
- 7.52% and 5.68% respectively.
Correct Answer: 3
Yield = NOI/Sale Price
Net Operating Income Calculation: Tommy’s Towers A Patricia’s Place B
Gross Potential Rent $720,000 $860,000
+ Potential Parking Revenue 9,400 10,200
+ Potential Laundry Revenue 4,100 5,300
= Gross Potential Revenue 733,500 875,500
Less Vacancy and Bad Debt Allowance (22,005) (26,265)
= Gross Realized Revenue 711,495 849,235
Less Operating Expenses (243,000) (255,000)
Net Operating Income 468,495 594,235
Yield Calculation:
Comparable A: Yield = $468,495 ÷ $8,250,000 = 0.0567873, rounded to 5.68%
Comparable B: Yield = $594,235 ÷ $7,900,000 = 0.0752196, rounded to 7.52%
An appraiser has obtained the following information on the subject property, an apartment building, and four comparables:
COMPARABLES
Subject Property
A
B
C
D
Number of Suites
75
94
60
49
70
Gross Potential Rent
461,800
765,500
454,600
295,400
488,300
Age of Building
16 years
6 years
7 years
13 years
20 years
Vacancy & Bad Debt Allowance
5.00%
4.00%
4.50%
4.50%
5.00%
Real Property Taxes
51,567
70,770
42,354
28,631
46,301
Utilities
31,760
37,640
29,050
21,920
34,470
Maintenance
29,840
38,500
25,700
19,000
28,600
Replacement Reserves
0
22,000
15,000
12,000
18,600
Depreciation
30,000
75,000
65,000
40,000
55,000
Management Fee
51,000
28,500
18,000
19,000
29,000
Miscellaneous Expenses
18,600
28,900
19,500
10,200
19,800
Net Operating Income
?
508,570
284,539
171,356
?
Sale Price
?
8,072,500
4,377,500
3,116,000
4,101,600
The subject property is located in the same general neighbourhood as the comparables and is in an average state of repair. The heating system is in need of immediate repairs which are expected to cost $202,950.
What is the net operating income of Comparable D?
- $287,114
- $258,469
- $282,427
- $264,580
Correct Answer: 1
Gross potential rent $488,300
Less vacancy and bad debt allowance 24,415
Gross effective rent $463,885
Less operating expenses:
Real property taxes $46,301
Utilities 34,470
Maintenance 28,600
Replacement reserves 18,600
Management fee 29,000
Miscellaneous expenses 19,800 176,771
Net operating income $287,114
An appraiser has obtained the following information on the subject property, an apartment building, and four comparables:
COMPARABLES
Subject Property
A
B
C
D
Number of Suites
75
94
60
49
70
Gross Potential Rent
461,800
765,500
454,600
295,400
488,300
Age of Building
16 years
6 years
7 years
13 years
20 years
Vacancy & Bad Debt Allowance
5.00%
4.00%
4.50%
4.50%
5.00%
Real Property Taxes
51,567
70,770
42,354
28,631
46,301
Utilities
31,760
37,640
29,050
21,920
34,470
Maintenance
29,840
38,500
25,700
19,000
28,600
Replacement Reserves
0
22,000
15,000
12,000
18,600
Depreciation
30,000
75,000
65,000
40,000
55,000
Management Fee
51,000
28,500
18,000
19,000
29,000
Miscellaneous Expenses
18,600
28,900
19,500
10,200
19,800
Net Operating Income
?
508,570
284,539
171,356
?
Sale Price
?
8,072,500
4,377,500
3,116,000
4,101,600
The subject property is located in the same general neighbourhood as the comparables and is in an average state of repair. The heating system is in need of immediate repairs which are expected to cost $202,950.
The indicated market yield on the sale of the comparables is within which one of the following ranges?
- 3.0% to 4.8%
- 4.5% to 6.1%
- 5.5% to 7.0%
- 6.0% to 10.0%
Correct Answer: 3
Yield = NOI ÷ Sale Price
Comparable
A $508,570 ÷ $8,072,500 = 6.3%
B $284,539 ÷ $4,377,500 = 6.5%
C $171,356 ÷ $3,116,000 = 5.5%
D $287,114 ÷ $4,101,600 = 7.0%
The comparables indicate a market yield between 5.5% − 7.0%.
An appraiser has obtained the following information on the subject property, an apartment building, and four comparables:
COMPARABLES
Subject Property
A
B
C
D
Number of Suites
75
94
60
49
70
Gross Potential Rent
461,800
765,500
454,600
295,400
488,300
Age of Building
16 years
6 years
7 years
13 years
20 years
Vacancy & Bad Debt Allowance
5.00%
4.00%
4.50%
4.50%
5.00%
Real Property Taxes
51,567
70,770
42,354
28,631
46,301
Utilities
31,760
37,640
29,050
21,920
34,470
Maintenance
29,840
38,500
25,700
19,000
28,600
Replacement Reserves
0
22,000
15,000
12,000
18,600
Depreciation
30,000
75,000
65,000
40,000
55,000
Management Fee
51,000
28,500
18,000
19,000
29,000
Miscellaneous Expenses
18,600
28,900
19,500
10,200
19,800
Net Operating Income
?
508,570
284,539
171,356
?
Sale Price
?
8,072,500
4,377,500
3,116,000
4,101,600
The subject property is located in the same general neighbourhood as the comparables and is in an average state of repair. The heating system is in need of immediate repairs which are expected to cost $202,950.
The operating expenses listed for the subject are as reported by the owner. The appraiser makes two modifications in order to stabilize the net operating income and have it reflect market norms. Determine which one of the following choices illustrates the most appropriate adjustments and the appropriate net operating income for the subject property.
- Adjustment 1: Depreciation = $50,000
Adjustment 2: Maintenance = $46,100
Estimated NOI: NOI=$240,508 - Adjustment 1: Immediate repairs = $202,950
Adjustment 2: Management Fee = $55,500
Estimated NOI: NOI=$266,008 - Adjustment 1: Management Fee = $25,500
Adjustment 2: Depreciation = $60,000
Estimated NOI: NOI=$222,108 - Adjustment 1: Management Fee = $24,000
Adjustment 2: Replacement Reserves = $16,900
Estimated NOI: NOI=$266,043
Correct Answer: 4
Adjustments must be made to the operating expenses of the subject property whenever these expenses are out of line with the amount paid by comparable properties for the same items.
In the problem, the subject property does not make any deduction for replacement reserves while all four of the comparables account for replacement reserves. It appears then, that by not allocating an amount to replacement reserves for the subject the property is out of line compared to other similar properties and an amount should be allocated.
The adjustment is estimated by considering the site condition and age of the subject property, the amount paid by comparables and any other factors the appraiser considers relevant. An adjustment of $16,900 is made to the operating expenses of the subject property to account for replacement reserves.
Similarly, the amount the subject property pays for management ($51,000) seems out of proportion to the management fees of the comparable properties ($28,500, $18,000, $19,000 and $29,000). The management fee for the subject property is adjusted to $24,000.
Note that depreciation is not adjusted because depreciation is not an operating expense. Depreciation is an accounting item and is irrelevant for the purposes of determining net operating income for appraisal purposes. Likewise, immediate repairs are deducted from the final estimate of market value and are not accounted for under operating expenses.
The NOI for the subject property is $266,043 ($461,800 - $23,090 (for vacancy) - $51,567 - $31,760 - $29,840 - $18,600 - $24,000 - $16,900).
An appraiser has obtained the following information on the subject property, an apartment building, and four comparables:
COMPARABLES
Subject Property
A
B
C
D
Number of Suites
75
94
60
49
70
Gross Potential Rent
461,800
765,500
454,600
295,400
488,300
Age of Building
16 years
6 years
7 years
13 years
20 years
Vacancy & Bad Debt Allowance
5.00%
4.00%
4.50%
4.50%
5.00%
Real Property Taxes
51,567
70,770
42,354
28,631
46,301
Utilities
31,760
37,640
29,050
21,920
34,470
Maintenance
29,840
38,500
25,700
19,000
28,600
Replacement Reserves
0
22,000
15,000
12,000
18,600
Depreciation
30,000
75,000
65,000
40,000
55,000
Management Fee
51,000
28,500
18,000
19,000
29,000
Miscellaneous Expenses
18,600
28,900
19,500
10,200
19,800
Net Operating Income
?
508,570
284,539
171,356
?
Sale Price
?
8,072,500
4,377,500
3,116,000
4,101,600
The subject property is located in the same general neighbourhood as the comparables and is in an average state of repair. The heating system is in need of immediate repairs which are expected to cost $202,950.
The appraiser, for reasons of their own, estimates a market capitalization rate of 5% and a net operating income for the subject property of $290,000. Given this information, and the status of the heating system, calculate the estimated market value of the subject property (rounded to the nearest $1,000).
- $6,003,000
- $5,800,000
- $5,597,000
- $5,497,000
Correct Answer: 3
Market Value
= Net Operating Income ÷ Capitalization Rate
= $290,000 ÷ .05
= $5,800,000
Less Immediate Repairs
($202,950)
Market Value
= $5,597,050, rounded to $5,597,000
You have been engaged to appraise an owner-operated multi-family building. The subject property’s operating expenses indicate that no property management fee was taken. When comparing the income data of your comparable properties you find that:
Comparable A is also owner-operated, with no property management fee taken; and
Comparable B uses a professional property management company that charges the standard industry rate of 2% of gross potential revenue. The data is summarised below:
Subject Property
Comparable A
Comparable B
Sale Price
? $1,216,382 $1,239, 560
Gross Potential Revenue
$115,560
$148,840
$100,500
Vacancy & Bad Debt Allowance
4%
4%
4%
Net Operating Income
$60,125
$57,850
$56,400
Based on this information, what is the market value range of the subject property, rounded to the nearest hundred dollars?
- $1,328,700 to $1,349,400
- $1,263,100 to $1,276,500
- $1,321,400 to $1,351,100
- $1,381,000 to $1,438,600
Correct Answer: 2
Subject Property
Comparable A
Comparable B
Reported NOI
$60,125
$57,850
$56,400
Adjustment for property management fee (2%)
+$2,010
Adjusted NOI
$60,125
$57,850
$58,410
Recent Sale Price
$1,216,382
$1,239,560
Capitalization Rate
4.76%
4.71%
Lower Bound: $60,125/0.0476 = $1,263,130 rounded to $1,263,100
Upper bound: $60,125/0.0471 = $1,276,539 rounded to $1,276,500
