The subject property has stabilized annual real property NOI of $148,000 after operating expenses and property taxes. The overall capitalization rate is 8%. What value is indicated by direct capitalization, to the nearest dollar?
Correct Answer
C) $1,850,000
Value = annual NOI ÷ overall capitalization rate = $148,000 ÷ 0.08 = $1,850,000.00, or $1,850,000. NOI is the stated property-level amount, not gross receipts or cash flow after debt service.
Why This Is the Correct Answer
Option C is correct because $148,000 ÷ 0.08 = $1,850,000. Direct capitalization divides the stated property-level NOI by the overall rate.
Why the Other Options Are Wrong
Option A: $148,000
Option A, $148,000, restates the annual NOI without capitalizing it. One year of income is not the property's value; $148,000 ÷ 0.08 = $1,850,000.
Option B: $11,840
Option B, $11,840, multiplies NOI by the rate ($148,000 × 0.08) instead of dividing. The correct value is $148,000 ÷ 0.08 = $1,850,000.
Option D: $18,500,000
Option D, $18,500,000, comes from misplacing the decimal when converting 8% and dividing by 0.008 instead of 0.08: $148,000 ÷ 0.008 = $18,500,000. The correct value is $148,000 ÷ 0.08 = $1,850,000.
IRV: Income over Rate
I = R × V, so Value equals Income divided by Rate.
How to use: Use the IRV triangle whenever two of income, rate and value are given.
Exam Tip
At an 8% rate, value should be 12.5 times NOI; use that to eliminate answers off by a factor of ten.
Common Mistakes to Avoid
- -Multiplying NOI by the rate
- -Converting 8% to 0.008 instead of 0.08
- -Capitalizing cash flow after debt service instead of NOI
Concept Deep Dive
Analysis
This question applies Value = NOI ÷ overall rate to a stabilized NOI of $148,000 at 8%. The NOI is already net of expenses and taxes, so the only step is to divide by 0.08.
Background Knowledge
Direct capitalization converts a single year's stabilized income into value using a market-derived rate. The overall rate is extracted from comparable sales as net income divided by cash-equivalent price, so NOI must be defined consistently.
Real-World Application
An appraiser values a single-tenant medical office building with stabilized NOI of $148,000. Sales of similar buildings support an 8% overall rate, indicating $1,850,000.
More Income Approach Questions
Which model describes yield capitalization of property benefits?
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Previous Question
An appraiser is extracting an overall rate for a fourplex. A comparable fourplex sold for a cash equivalent $600,000, with annual PGI of $72,000, vacancy and credit loss of 5%, operating expenses of $20,400 and buyer's mortgage payments of $31,000. The subject property has annual PGI of $84,000, the same 5% loss and operating expenses of $25,000. Neither property has other income. What is the indicated value of the subject property?
Next Question
An appraiser is developing an overall capitalization rate for an apartment building. Typical financing for similar properties is a 75% loan-to-value loan at 6.0% interest with a 7.8% annual mortgage constant. Equity investors expect a 10% first-year cash-on-cash return and a 13% equity yield over the holding period. What overall capitalization rate is indicated by the band of investment?