Stabilized annual NOI for the subject property is $75,000, and the overall capitalization rate is 7.5%. What is the indicated value, rounded to the nearest dollar?
Correct Answer
C) $1,000,000
75000÷0.075 = 1000000. Common errors: multiplying NOI by the rate instead of dividing gives $5,625; misplacing the decimal in the rate gives $100,000; shifting the rate’s decimal the other way (0.75% for 7.5%) gives $10,000,000.
Why This Is the Correct Answer
Option C is correct because $75,000 ÷ 0.075 = $1,000,000. Dividing stabilized NOI by the overall rate gives the direct capitalization value indication.
Why the Other Options Are Wrong
Option A: $5,625
Option A, $5,625, comes from multiplying NOI by the rate instead of dividing: $75,000 × 0.075 = $5,625. The correct calculation is $75,000 ÷ 0.075 = $1,000,000.
Option B: $100,000
Option B, $100,000, comes from misplacing the decimal in the rate so that 7.5% is treated as 75%: $75,000 ÷ 0.75 = $100,000. Using 0.075 gives $1,000,000.
Option D: $10,000,000
Option D, $10,000,000, comes from shifting the decimal the other way, treating 7.5% as 0.75%: $75,000 ÷ 0.0075 = $10,000,000. Using 0.075 gives $1,000,000.
Move the decimal two places
7.5% becomes 0.075 by moving the decimal two places left; one place or three places gives an answer off by ten times.
How to use: Use this before dividing by any percentage rate on the exam.
Exam Tip
When answer choices differ by factors of ten, recheck your decimal conversion before choosing.
Common Mistakes to Avoid
- -Entering 7.5% as 0.75
- -Entering 7.5% as 0.0075
- -Multiplying NOI by the rate
Concept Deep Dive
Analysis
This question tests correct use of V = NOI ÷ rate with a percentage rate. The rate must be entered as 0.075 before dividing. Wrong answers come from multiplying instead of dividing or shifting the decimal in either direction.
Background Knowledge
Direct capitalization divides one year's stabilized NOI by an overall rate to estimate value. A percent rate must be converted to a decimal by dividing by 100. Small errors in decimal placement change value by a factor of ten.
Real-World Application
An appraiser enters a 7.5% capitalization rate into a spreadsheet as 0.75 by mistake and gets a value far below the sales comparison approach. Reconciling the approaches reveals the error. The corrected rate of 0.075 brings the income approach into line.
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