Transcript reconstructed operating income statement

Chapter 3
3
Income and Expense Analysis
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Chapter Objectives
3
• Upon completion of this chapter, the
participant will be able to:
– Recognize critical information related to the appraiser’s
lease analysis
– Recall recognized methods and techniques for
estimating and applying market level rent as a
component of the appraiser’s value analysis
– Estimate, from analysis of market data, various losses
and operating expenses associated with incomeproducing properties
– Identify the method and use of expense and income
ratios
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Key Terms
• Collection Loss
• Estate for Years
• Net Income Ratio
(NIR)
• Operating Expense
Ratio (OER)
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• Periodic Tenancy
• Reconstructed
Operating Income
Statement
• Rent Roll
• Rent Survey
• Vacancy Rate
3
Lease Analysis
3
• Level of analysis is determined by scope of
work:
– Amount of agreed-upon rent
– Term of lease (e.g., month-to-month, one year)
– Provisions for rent or terms to change
– Beginning and ending date
– Personal property included
– Expenses paid by landlord/tenant
– Other services/amenities provided by landlord
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Analyzing Lease Documents
3
• Easier for smaller residential income
properties than those with a large number
of units
• Leases are not standard and can vary in
style, format, and content
• Not all of the content will be meaningful to
the appraiser
– Some portions are of special interest
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Analyzing Lease Documents
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continued
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Analyzing Lease Documents
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continued
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Analyzing Lease Documents
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continued
• Month-to-month agreements are referred to
in many areas as a periodic tenancy
– When the rent is paid for that month (or some
other period of time), the lease automatically
renews until the rent is due at the beginning of
the next period
• When the lease agreement is for a specified
period of time (e.g., 6 months or 1 year), the
agreement creates a leasehold estate known
in some areas as estate for years or a term
tenancy
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Analyzing Lease Documents
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continued
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Analyzing Lease Documents
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continued
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Analyzing Lease Documents
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continued
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Analyzing Lease Documents
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continued
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Rent Roll
3
• Briefly details the unit information, lease terms,
and contract rent, as well as the effective date of
the leases that are in place for the property
– Can be compiled by the client or property owner
as an alternative to presenting each individual
lease
– Could be created as a summary of the lease
terms and information by the appraiser after he
examines individual lease documents
– Appraiser might develop a rent roll based upon
an interview with the client or property owner
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Rent Roll Example
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Estimating Market Level Rent
3
• Determining an applicable market level rate
of rent for subject property is the core of the
appraiser’s income analysis for any incomeproducing property
• If data is plentiful and relevant, this will be
relatively simple
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Rent Surveys
3
• A compilation of the rents being
generated, and often rent history, in a
particular market for a particular property
type
• Should include properties that share
similar:
– Locational desirability
– Physical characteristics
– Lease terms and conditions
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Rent Survey Example
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Adjusting Rent Data
3
• Some physical differences can be
observed for which a dollar amount could
be assigned for the possible adjustments
• The scope of work might require the
appraiser to further analyze different
elements of market appeal
– Knowledge of market and market
participants will assist the appraiser with
this recognition
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Deriving Rent Adjustments
Example 1
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Deriving Rent Adjustments
Example 2
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Applying Rent Adjustments
3
Bedroom--$50 per month
Central Air-Conditioning--$25 per month
Covered Parking--$50 per month
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Estimating Vacancy and
Collection Losses
3
• Losses due to vacancy and collection are
usually based on a percentage of the PGI
• The percentage applied is derived from
information obtained through:
– The property owner
– Analysis of leases or rent roll
– Market data of other similar properties
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Deriving a Vacancy Rate
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• Vacancy Rate: A percentage rate for all
units comprised of the total number of
unrented days divided by the total number of
rentable days in a year
– Should always reflect market level
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Deriving a Vacancy
Rate Example
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Subject’s Vacancy Rate:
28 Days ÷ 1,460 Days (365 x 4 units) = 1.92% (Vacancy Rate)
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Deriving a Vacancy
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Rate Example continued
• The subject property owner’s estimation of
vacancy is not representative of market level
• Since the subject has four units, market level
vacancy rates would fall somewhere between
2.38% and 2.51%
• If the subject’s PGI was $36,000 ($750 x 4 units x
12 months) and a vacancy rate of 2.50% was
determined to be appropriate for the subject, the
vacancy loss would be $900
$36,000 x 2.50% (0.025) = $900
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Treatment of Collection Losses
3
• Collection (or credit) loss: An amount stated
as a percent or a dollar amount reflecting the
risk anticipated for nonpayment of rent by
tenants
• Appropriate when the market supports that
there is evidence in the market for its use
– Can be derived from surveys similar to that which
was performed to derive a market vacancy rate
• When warranted, it is applied to PGI in the
same manner as the percentage for vacancy
loss
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Expense Analysis
3
• Market level operating expenses must be
estimated when scope of work includes the
analysis of NOI
• Data ideally provided by, or through an
interview with the property owner
• Appraiser will typically develop a
reconstructed operating income
statement:
– A statement prepared by the appraiser that
reflects anticipated net operating income (NOI)
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Expense Analysis Example
3
• See extensive example on pages 33-35
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Operating Income Analysis
3
• Extensive analysis is common for larger
multi-family properties
• A specific form reporting the reconstructed
operating income statement is most often
a client requirement for 2- to 4-unit
residential properties when appraisal is to be
used in a mortgage finance transaction
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Reconstructed Operating
Income Statement
3
• Next step after estimating market level
rent/income, as well as market level
expenses
• The net operating income concluded in this
analysis represents a one-year projection for
the property
• See Example on page 36
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Expense and Income Ratios
3
• Types of ratios:
– Operating Expense Ratio (OER)
– Net Income Ratio (NIR)
• Regardless of which the appraiser chooses,
the comparison should be consistent (e.g.,
comparing the OER for the subject to the
OER from the market)
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Operating Expense Ratio (OER) 3
• The ratio of total operating expenses to
effective gross income, expressed as a
percentage
Total
Operating
Expenses
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÷
Effective
Gross
Income
=
OER
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Operating Expense
Ratio (OER) Example
3
• The subjects total operating expenses = $17,008
• The subject’s effective gross income = $35,100.
• Thus, the OER for the subject is 48.46%
$17,008 ÷ $35,100 = 0.4846 or 48.46%
Subject’s OER is reasonable and
bracketed within the data
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Net Income Ratio (NIR)
3
• The ratio of net operating income to
effective gross income, expressed as a
percentage
Net
Operating
Income
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÷
Effective
Gross
Income
=
NIR
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Net Income Ratio (NIR) Example
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• The subject’s indicated NOI = $18,092
• The subject’s effective gross income =$35,100
• Thus, the NIR for the subject is 51.54%.
$18,092 ÷ $35,100 = 0.5154 or 51.54%
Subject’s NIR appears reasonable and is
bracketed within the data
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Chapter 3 Quiz
3
1. A three-unit apartment building had two
units vacant for ten days each during
the past year with the third unit being
vacant for 17 days. What is the annual
vacancy rate indicated by the data?
a.
b.
c.
d.
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2.41%
3.14%
3.38%
3.97%
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Chapter 3 Quiz
3
2. In a market value assignment, the
contract rent of the subject should be
a. the basis of the appraiser’s analysis for owneroccupied units.
b. discussed in the appraisal report at the
appropriate level of detail.
c. disregarded, since it never reflects market
level.
d. used as EGI in every income analysis.
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Chapter 3 Quiz
3
3. When an amenity common to the market
is provided by the subject property’s
landlord per the terms of the lease, the
cost of the amenity must be included
when developing
a.
b.
c.
d.
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debt service.
effective gross income.
market level operating expenses.
rent surveys.
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Chapter 3 Quiz
3
4. Analysis of a two-unit property includes developing
appropriate replacement reserves for the subject
property. Rounded to the nearest dollar, what should
be the total annual replacement reserve for the
property?
Years
Estimated
Item
a.
b.
c.
d.
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$3,667
$4,487
$5,852
$6,187
Remaining
Cost
Carpet
3
$3,800
HVAC
10
$7,200
Appliances
4
$6,000
Roof
12
$12,000
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Chapter 3 Quiz
3
5. Which is a factor used in the appraiser’s
analysis that represents the ratio of
total operating expenses and effective
gross income?
a.
b.
c.
d.
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EGI
NIR
NOI
OER
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Chapter 3 Quiz
3
6. If a four-unit apartment building with a
PGI of $950 per unit had a total vacancy
of 63 days during the year, what was the
EGI?
a.
b.
c.
d.
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$40,380
$41,570
$43,630
$45,790
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Chapter 3 Quiz
3
7. Using these adjustments, what is the
indicated adjusted rent to be applied to the
subject?
Subject
Comparable Comparable
Bedroom—$75
Central A/C—$50
Covered Parking—$25
a.
b.
c.
d.
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$1,050
$1,200
$1,250
$1,275
Unit
Unit #1
Unit #2
Contract
Rent
(Monthly)
__
$1,225
$1,075
Bedrooms
3
3
2
Central A/C
Yes
Yes
No
None
Yes
None
Covered
Parking
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Chapter 3 Quiz
3
8. Which item would NOT be considered
an operating expense?
a.
b.
c.
d.
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accounting expense for property
commission payment to property manager
landscape maintenance
mortgage payment
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Chapter 3 Quiz
3
9. Rounded to the nearest dollar, if the EGI
for a three-unit property is $22,560, what is
the NOI if the net income ratio is 46.57%?
a.
b.
c.
d.
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$10,506
$11,731
$12,337
$13,639
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Chapter 3 Quiz
3
10. For the purpose of analysis, the
appraiser gathers the subject’s income
and expense data from the property
owner to assist in developing a
a.
b.
c.
d.
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reconstructed operating income statement.
rent adjustment.
rent survey.
vacancy loss.
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