Annual EGI for the subject property is $120,000, and all annual property expenses total $48,000, excluding debt service. Market data indicate a 7.5% overall rate. What is the indicated value?
Correct Answer
B) $960,000
(120000−48000)÷0.075 = 960000. Common errors: capitalizing EGI instead of NOI gives $1,600,000; misplacing the decimal in the 7.5% rate gives $96,000; adding the expenses instead of deducting them gives $2,240,000.
Why This Is the Correct Answer
Option B is correct because NOI is $120,000 − $48,000 = $72,000, and $72,000 ÷ 0.075 = $960,000. The overall rate is applied to NOI, with 7.5% entered as 0.075.
Why the Other Options Are Wrong
Option A: $96,000
Option A, $96,000, comes from misplacing the decimal and dividing by 0.75 (($120,000 − $48,000) ÷ 0.75). Using 0.075 gives $72,000 ÷ 0.075 = $960,000.
Option C: $1,600,000
Option C, $1,600,000, capitalizes EGI instead of NOI ($120,000 ÷ 0.075). Deducting the $48,000 of expenses first gives $72,000 ÷ 0.075 = $960,000.
Option D: $2,240,000
Option D, $2,240,000, adds the expenses instead of deducting them (($120,000 + $48,000) ÷ 0.075). The correct NOI is $120,000 − $48,000 = $72,000, giving $960,000.
Percent to decimal: two places
Move the decimal two places left to convert a percentage: 7.5% becomes 0.075, not 0.75.
How to use: Use the two-places rule each time you enter a cap rate into a calculation.
Exam Tip
Sanity-check the size of the answer; values that differ by a factor of ten from the others usually come from a decimal error.
Common Mistakes to Avoid
- -Converting 7.5% to 0.75
- -Capitalizing EGI instead of NOI
- -Adding expenses to income
Concept Deep Dive
Analysis
This question tests deriving NOI from EGI and capitalizing at a decimal rate. NOI equals EGI of $120,000 minus $48,000 of expenses, which is $72,000. Dividing by 7.5% (0.075) gives value.
Background Knowledge
Net operating income equals effective gross income minus operating expenses, excluding debt service. Direct capitalization divides NOI by an overall rate expressed as a decimal. A misplaced decimal changes the result by a factor of ten.
Real-World Application
An appraiser estimates a small office building's EGI at $120,000 and expenses at $48,000. Capitalizing the $72,000 NOI at a 7.5% market rate gives an indicated value of $960,000.
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