Module 5: Income and Expense Analysis

Question 1

Lease

Answer 1

A contract in which the rights to use and occupy land or structures are transferred by the owner to another for a specified period of time in return for a specified rent.

Question 2

Lease Analysis

Answer 2

Where you will often begin the income capitalization approach

Question 3

Initial data for lease analysis typically includes

Answer 3

All existing and proposed leases for the subject property
informtaion about lease provisions for the subject property
Similar infromation for competitive proerties to be used in the analysis

Question 4

Gross Lease

Answer 4

The landlord (lessor) pays all of the operating expenses

Question 5

Net Lease

Answer 5

The tenant (lessee) pays all of the operating expenses

Question 6

Flat rental

Answer 6

A lease with a specifiec level of rent that continues throughout te lease term; also called a level payment lease

Question 7

Graduated Rental

Answer 7

A lease that provides for specified changes in rent at one or more points during the lease term

Question 8

Step up lease

Answer 8

the payments increase at specified intervals

Question 9

Step down lease

Answer 9

the payments decrease at specified intervals

Question 10

Reevaluation lease

Answer 10

A lease that provides for periodic rent adjustments based on a reevaluation of the real estate under prevailing market trental conditions. This is sometimes accomplished through appraisal or arbitration

Question 11

INdex leases

Answer 11

A lease typically long term that provides for periodic rent adjustments based on the change in an economic index, e.g. a cost -of-living index

Question 12

percentage lease

Answer 12

a lease in which rent or some portion of rent represents a specified percentage of the volume of business, productivity, or use achieved by the tenant. This type of lease is frequently used for retail. Most leases specify a gaurantee minimum rent with overage possible

Question 13

Rent

Answer 13

an amount paid for the use of land improvements or a capital good

Question 14

Types of Rent

Answer 14

Contract rent

Scheduled rent

Question 15

Market Rent

Answer 15

The most probable rent that a property should bring in a competitive and open market, each part acting prudently and knowledgeably

Question 16

Why estimate market rent

Answer 16

an estimate of market rent is probably going to be required to determine if the contract rent is above or below market rent. This has to do with the risk associated with receiving the contract rent. It makes sense that the more contract rent is above market rent, the more the risk of continuing to receive that rent increases. Conversely, the more contract rent is below market rent, the more the risk of continuing to receive that rent decreases. The amount of risk plays a major part in determining proper capitalization and discount rates.

Question 17

Effective rent

Answer 17

the rental rate net of financial concessions such as periods of no rent during the lease term; may be calculated on a discounted basis, reflecting the time value of money, or on a simple straight line basis

Question 18

Deficit Rent

Answer 18

the amount by which market rent exceeds contract rent at the time of the appraisal; created by a lease favorable to the tenant, resulting in a positive leasehold, and may reflect uninformed parties, inferior management, or a lease executed in a weaker rental market

Question 19

Excess Rent

Answer 19

the amount by which a contract exceeds market rent at the time of the appraisal; created by a lease favorable to the landlord (lessor) and may reflect unknowledgeable parties or a lease execution in an earlier stronger rental market, it may be calculated separately and capitalized at a higher rate in the income capitalization approach.

Question 20

Overage rent

Answer 20

the percentage of rent paid over and above the guaranteed minimum rent of base rent; calculated as a percentage of sales in excess of a specified breakeven sales volume. This is not excess rent, but is a contract rent

Question 21

Difference between a rent analysis for fee simple interest and a rent analysis for a lease fee (lessors or landlords) interes

Answer 21

A fee simple interest would be based on the market rent the property is capable of achieving

Rent analysis for leased fee (lessor’s or landlord’s) interest would be based on existing contract rent for leased space and market rent for vacant and owner-occupied space.

Question 22

Potential Gross Income (PGI)

Answer 22

The total rent possible if the property is 100% occupied.

Question 23

PGI includes

Answer 23

1. Scheduled rent (contract rent)
2. . Escalation rent. Derived from lease escalation clauses
3. Market rent. Estimated for vacant, soon to be vacant, or owner occupied space.
4. Other income. Income generated by the operation of the real property not derived from rental pf space. Examples are parking fees, coin operated machines, and antenna connections

Question 24

Effective Gross Income

Answer 24

PGI minus the allowance for vacancy and collection loss

Question 25

EGI

Answer 25

The income that a property manager is expected to handle during the next 12 months or income to be collected during the next 12 months

Question 26

operating expenses

Answer 26

The periodic expenditures necessary to maintain the real property and continue production of the effective gross income, assuming prudent and competent management.

Question 27

3 groups of expenses

Answer 27

Fixed expense
Variable expense
Replacement allowance

Question 28

Fixed Expenses

Answer 28

operating expenses that generally do not vary with occupancy, and that prudent management will pay whether the property is occupied or vacant. Examples include real estate taxes and property insurance for fire, extended coverage, and owner’s liability.

Question 29

Variable Expenses

Answer 29

operating expenses that generally vary with the level of occupancy or the extent of services provided. Examples include management charges, utilities, and maintenance and repairs.

Question 30

Replacement Allowance

Answer 30

an allowance that provides for the periodic future replacement of short lived building components that wear out more rapidly than the building itself and must be replaced periodically during the building’s life. Examples of short lived components include roof covering, carpeting, boilers, and driveways. The annual allowance for each component is usually estimated as the anticipated cost of its replacement prorated over its anticipated total useful life, provided this does not exceed the remaining useful life of the structure.

Question 31

Operating Expense Ratio

Answer 31

ratio of total operating expense to effective gross income. OE/EGI

5400 (OE) / 120000 (EGI) = .45 or 45%

Which means that operating expense consumes 45% of all collected income

Question 32

Net Income Ratio

Answer 32

the ratio of net operating income to effective gross income. NOI/EGI

Complement of the OER ratio. If OER is 45%, then 45-1=55 NIR is 55%

OER and NIR always sum to 1

Question 33

Debt coverage Ratio

Answer 33

the ratio of operating income to annual debt service. Measures the ability of a property to meet its debt service out of net operating income and may also be called debt service converage ratio.

DCR = Operating Income / Annual Debt Service

Question 34

A multi-unit apartment building has a net operating income of $505,000 and an operating expense ratio (OER) of 43.56%. Vacancy is estimated at 4% in the market. What is the net income ratio (NIR)?

A) 56.44%
B) 64.39%
C) 41.82%
D) 39.56%

Answer 34

A) 56.44%
Feedback: The net income ratio (NIR) can be calculated by taking the complement of the operating expense ratio. In this case, 1 0.4356 = 0.5644, or 56.44%.

Question 35

A property has a potential gross income of $600,000. Vacancy and collection loss are estimated at 10% in the market, and operating expenses total $250,000. What is the net operating income (NOI)?
A) $275,000 
B) $350,000 
C) $290,000 
D) $300,000

Answer 35

C) $290,000
Feedback: Recall that potential gross income (PGI) minus vacancy = effective gross income (EGI) minis operating expenses (OE) = Net operating income (NOI). So in this case, $600,000 x .90 = 540,000 - 250,000 = $290,000

Question 36

There are various data sources an appraiser considers in analyzing the operating expense for a property. Which source is likely to provide the best expense information?

A) The local tax assessor’s office
B) Data published by the Institute of Real Estate Management (IREM)
C) Data published by the Building Owners and Managers Association (BOMA)
D) The actual operating history of the subject property

Answer 36

D) The actual operating history of the subject property

Feedback: Rent and expense analysis should begin with the subject property, going back at least three years if possible.

Question 37

A retail building has a net operating income of $45,000 and an operating expense ratio (OER) of 55%. Vacancy is estimated at 4% in the market. What is the net income ratio (NIR)?

A) 45% .
B) 40%
C) 60%
D) 55%

Answer 37

A) 45%

Feedback: The net income ratio (NIR) can be calculated by taking the complement of the operating expense ratio. In this case, 1 - 0.55 = 0.45, or 45%.

Question 38

Which type of lease may adjust due to changes in market rent and may be facilitated through the use of an appraisal or arbitration?

A) Index lease
B) Revaluation lease
C) Graduated lease
D) Percentage lease

Answer 38

B) Revaluation lease

Feedback: This lease provides for periodic rent adjustments based on a revaluation of the real estate under prevailing market rental conditions.

Question 39

How does an appraiser usually calculate vacancy and collection loss?

A) As a percentage of potential gross income
B) As a percentage of effective gross income
C) As a percentage of net operating income
D) As a percentage of market rent

Answer 39

A) As a percentage of potential gross income

Feedback: Vacancy and collection loss is typically calculated as a percentage of gross potential income.

Question 40

Which of the following would be considered a fixed expense?

A) An operating expense that does not change with occupancy
B) An expense based on a percentage of effective gross income
C) An operating expense that changes with occupancy
D) Any expense to fix the property

Answer 40

A) An operating expense that does not change with occupancy

Feedback: A fixed expense is typically not expected to vary with the occupancy of the building.

Question 41

A property has a net operating income of $355,500. The fixed expenses are $110,200 and variable expenses are $125,000. What is the effective gross income (EGI)?

A) $230,500
B) $590,700
C) $245,300
D) $120,300

Answer 41

B) $590,700

Net income comes after subtracting operating expenses such as fixed and variable expenses. Effective gross income is before expenses are take out.

$355,500 + $110,200+$125,000 = $590,700 EGI

(working backwards)

Question 42

Suppose a lease contract called for a rent of $10 per square foot. However, a similar space in the market rented for $15 per square foot. What is the amount specified in the lease known as?

A) Contract rent
B) Market rent
C) Economic rent
D) Overage rent

Answer 42

A) Contract rent

Feedback: The amount specified in the lease is known as contract rent.

Question 43

What is the process of calculating effective gross income?

A) Divide potential gross income by operating expense
B) Subtract operating expenses from potential gross income
C) Subtract vacancy from potential gross income
D) Divide potential gross income by vacancy

Answer 43

C) Subtract vacancy from potential gross income

Feedback: When vacancy and collection loss is deducted from potential gross income, the result is effective gross income.