Final answer:
To support a $1.8 million asking price for an apartment property at a 6.5% cap rate, with VC&L at 5% of PGI and operating expenses at 40% of EGI, the required Potential Gross Income (PGI) is approximately $243,684.21 per year.
Step-by-step explanation:
Calculating the Required Potential Gross Income (PGI)
To determine the rent or Potential Gross Income (PGI) needed to support a $1.8 million price tag on an apartment property, we first need to understand a few real estate investment terms related to income-generating properties. Capitalization rate (cap rate), Vacancy, Credit Loss (VC&L), Effective Gross Income (EGI), Operating Expenses, and Potential Gross Income (PGI) are the key terms here.
The cap rate is an estimate of the investor's potential rate of return on an investment property. The formula to calculate the value based on cap rate is Value = NOI / Cap Rate, where NOI stands for Net Operating Income. To find the NOI required to support the $1.8 million value at a 6.5% cap rate, we use the formula NOI = Value × Cap Rate. Hence, NOI = $1,800,000 × 0.065, which equals $117,000 per year. Now, to find PGI, we adjust the NOI for VC&L and operating expenses. The VC&L are 5% of PGI, thus VC&L = PGI × 0.05. Operating expenses are 40% of EGI, so if we denote Operating Expenses as OE and EGI as EGI, OE = EGI × 0.40. However, EGI is actually PGI minus VC&L. So, putting it all together, we have EGI = PGI - (PGI × 0.05), and therefore OE = (PGI - (PGI × 0.05)) × 0.40, which simplifies to OE = (0.95 × PGI) × 0.40. Since NOI is EGI minus OE, then $117,000 = (PGI - (PGI × 0.05)) - ((0.95 × PGI) × 0.40). Through algebraic manipulation, we find that PGI needed to support the $1.8 million price tag is approximately $243,684.21 per year.