Instructions We already covered which expense items are proper and improper to deduct from effective gross income in order to calculate net operating income.

Let's look a little closer at the reserves for replacement category. Reserves for replacement are set aside annually to provide for the eventual replacement of short-lived items.

For example, Assume an owner states that it cost $4500 to paint and decorate 3 units this year. The assessor would not use $4,500 for the expense of painting and decorating. It would cost $1,500 per unit, $4,500 divided by 3). Say there are 24 units in the building. Assume they all will have to be painted and decorated once every 3 years. Multiply the $1,500 (per unit cost) times 24 units. The product is $36,000. Divide $36,000 by 3 (the number of years in between painting and decorating) and you get $12,000. $12,000 is what you would put for the expense line item for painting.

Instructions You are asked to appraise a 24-unit apartment house. You have the owner's operating statement prepared by his accountant. After careful analysis, you decide that all items are basically correct. However, the owner did not include, in his statement, an allowance for vacancy and collection loss, which you estimate to be 3% of potential gross income. Also, he did not include anything for management, which you estimate to be 5% of effective gross income. Painting and decorating must be prorated over a three year period.

The owner's operating statement appears as follows:

Owner's Statement Your estimate

Potential gross income $201,000

Vacancy and Collection Loss -0-

Effective Gross Income $201,000

Expenses

Management -0-

Employee's Salaries 18,901

Employee's benefits 1,200

Insurance 3,887

Gas 7,469

Painting & decorating (3 units) 4,500

Payment on loan for air conditioner 3,000

Repairs 4,680

Supplies 1,134

Electricity 2,685

Water 865

Real Estate taxes 18,090

Depreciation 31,248

Interest on Mortgage 67,200

Legal & accounting fees 2,700

Principal on Mortgage 10,599

Miscellaneous expense 1,800

Total expenses $179,958

Net operating income $21,042