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Operating Income Statement

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KYLECODY

Senior Member
Joined
Apr 26, 2003
Professional Status
Certified Residential Appraiser
State
Arizona
Quick ? What is the proper way to determine if you use the current actual rent or your estimated market rent for the page 2 calculations on the operating income statement?
Thanks
 

Fred

Elite Member
Joined
Jan 15, 2002
Professional Status
Retired Appraiser
State
Virgin Islands
Here are the most frequently used words in appraising. "It depends."

I would say, in all likelihood, you need the actual rental income because the purpose of you assignment is likely the actual or "as is" value. Although, I have seen folks use their own "estimate" of gross as a substitute for contract rent and call that "as is."
 

Bobby Bucks

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Jan 27, 2002
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Real Estate Agent or Broker
State
North Dakota
I typically use estimated market rent for these reasons. (1) Quite often the current tenant has been in the property for over one year and is on month to month per the lease after the first 12 months. The owner has not increased the rent because they are a good tenant or they know if they increase the rent too much they will have repairs/updating which will not be offset by the rental increase, therefore they leave the tenant alone and the rent is slightly below market rent. (2)The tenant might be a friend or relative paying less than market rent. (3)The owner might be stupid and not charging enough (4) If the property is multi-family a combination of examples 1,2 3 above might exist or one or more units might be vacant. I like using estimated market rent.

Waiting anxiously for the analites to weigh in on this one. :)
 

George Hatch

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Jan 15, 2002
Professional Status
Certified General Appraiser
State
California
Analite #1, here....

I agree with Bobby but for slightly different reasons. When it comes to properties with rental income, I've found it equally common that the reported incomes are above what the market will bear. Actual expense ratios can also commonly vary widely from what is appropriate for long term ownership requirements. It's very common for an owner to report high rents and low expenses to make the property look good to an unsuspecting buyer and/or appraiser. The tip off comes when there are several rental agreements, all on the same form, filled in on the same date with the same pen and the same handwriting, but with different signatures. You run into that, and there's a 50% chance the rents are 'inaccurate'.

Using anything other than market rent in these situations is going to cause problems with the valuation. This is especially true when you're looking for GRM/GIM indicators and cap rates. Using a number of comparable data, some reporting market rents and others reporting actual rents and/or expenses that may not be in line with the market, you're going to end up with a much wider range of indicators; possibly wide enough to be unreliable as such. This happens because you're comparing apples (actual) to oranges (market).

Much better to project market rents (and expenses) for the subject and each of the comparables so that you can see what the investor sees; potential income and returns. That way, it's all oranges. In my experience, using market level rents and expenses for all of the properties invariably results in a much tighter range for these income-derived indicators. Even for 2-4s.

I always look for market rents and expenses; if the actual incomes reported for the subject and/or the sales appears reasonable within this market range, I just go ahead and use them. If they aren't reasonable, I make make own estimates. Sometimes I can use the income but have to estimate more reasonable expenses, other times I use the actual expenses but not the income. No matter what, I disclose this methodology in my report so that the reader understands how I got there. If I'm appraising a market segment where there isn't enough rental data to make a realistic estimate, I just leave it alone and report what there is. I never have to do that with apartments, though; there's always enough data.

Now this choice usually is applicable only for those properties that are not encumbered with leases. Obviously, with a property that has a long term lease (which would be a legal encumbrance), the contract rent has to be given much more consideration. Apartments are usually rented on a month-month basis or else have short term leases of less than a year that would not significantly affect the long term income potential enough to require discounting.

Use market rents, or else be sure that the actual reported rents are completely in line with all your comparable data (a situation I have never seen in apartment appraising). Apples to apples, oranges to oranges.


George Hatch
 

Fred

Elite Member
Joined
Jan 15, 2002
Professional Status
Retired Appraiser
State
Virgin Islands
George, when you say, “Now this choice usually is applicable only for those properties that are not encumbered with leases” I don’t think you are agreeing with Bobby. He seems to be saying ignore leases and use market rent. He said, “I typically use estimated market rent for these reasons.”

George, if the owner is giving you phony information, you cannot just substitute market rent and expenses (a hypothetical or extraordinary assumption?) in an “as is” appraisal. There are a lot of possibilities of who the client and intended users may be, and you getting phony information probably means you will have to go back to the client to compel the release of the true leases or re-figure the purpose of the appraisal, etc. to get an agreement for the assumptions.

It seems to me that the situation one must avoid is following Bobby’s advice and capitalizing stabilized “market” NOI of 100K when the actual NOI the buyer will receive is only 60K.
 

Phil Rice

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Joined
Apr 22, 2002
Professional Status
Certified Residential Appraiser
State
Colorado
I don't do apartments, I only do 1-4 family.

I value the property with GRM, which ignores expenses. When I do the income statement, I have already valued the property. In my mind, the income stmt has no bearing on the value of the property.

A typical situation for me is a 2 family, owner lives in one unit and rents the other. If the tenant is a related party, the actual rent is always below market rent. If the tenant is "arms length", the actual rent is either eqaul to or less than market rent.

If one unit is owner occupied, I report no income or expense from that unit on the income stmt. For all other units, I report the actual rent as income, and actual expenses that relate to the rented units. I think the purpose of the income stmt is to help the loan company decide how much "help" the owner will have in making the monthly payment. It is about credit score, and not about the value of the property. Do I have any back-up for how I arrived at that? Nope, I have none. I could be wrong.

I am convinced that no-one ever reads the income stmt. I often wonder if it is required, and have seriously considered not doing it to see if anyone noticed. I have always been able to convince myself that it is easier and faster to just do the form than to ask the question. My goal is to get the report done. I have never had a question from an underwriter (or anyone else) about the income stmt.
 

Fred

Elite Member
Joined
Jan 15, 2002
Professional Status
Retired Appraiser
State
Virgin Islands
Phil,
You make a good point. I was referring to "real" income-producing properties, where income cap is critical. I missed the meaning of the "page 2" item in the original post.
 

Ben Vukicevich SRA

Senior Member
Joined
Feb 9, 2002
Professional Status
Certified General Appraiser
State
New Jersey
Kyle,

Bobby has it correct.

I look at it this way. If it's a sale, I look for the clause in the agreement of sale that the tenant is vacating the property at closing or very shortly thereafter. If I see that, there will be no income stream for the borrower so I use market rents.

If it's a refi or the tenant is staying on for another year , I look at the lease to see if it is at market rent. If it is below, I use the actual rents. Not my problem the former owner is a moron and the new owner is following in his footsteps. If it is above market, they're probably playing games with a fake lease to a relative so I use the market rent.

Why? Remember, the FNMA/FHLMC Operating Income statement is nothing like an Operating Income Statement for an apartment or commercial property. Don't even try to compare them. FNMA's is in a world of its own. You're not valuing the property based on this silly non-sense. You're just filling out the form to help the underwriter qualify a borrower based on total income. That's why you don't use the income and expenses for the owner occupied unit on the form. That's also why there are no expenses for taxes, insurance and HOA dues on the form. They're somewhere else in the borrower qualification process.

Ben
 

KYLECODY

Senior Member
Joined
Apr 26, 2003
Professional Status
Certified Residential Appraiser
State
Arizona
Thanks for the replies. Another ? regarding this. On the operating income form under expenses what is the proper thing to do if their hoa covers heat, water, trash, etc. I just put "included in hoa" in the boxes and added in the monthly hoa fee under misc. expenses.. Is this correct? Thanks.
 

Mike Garrett RAA

Elite Member
Gold Supporting Member
Joined
Jan 14, 2002
Professional Status
Certified Residential Appraiser
State
Colorado
Two schools of thought on this one. If the units are rented and on leases, I use the actual rents because it is what it is. Is the property owner using the income from the property to qualify for the loan?

If you are doing a pro-forma income and expense analysis (which I prefer to do) you can use market rents rather than actual rents. I prefer this method because most owners do not maintain reserve accounts for maintenance and replacement anyway....so why not make up the whole thing based on present market rents and anticipated expenses.

In any event, most underwriters only look at the bottom line anyway. Is it a positive cash flow? Most should be with these very low interest rates.
 
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