An investment property's annual real estate taxes rise by $6,000. Tenants do not reimburse taxes, and income and all other expenses are unchanged. If the overall capitalization rate stays at 8%, how does the indicated value change?
Correct Answer
C) Decreases by $75,000
NOI falls by the $6,000 tax increase. Value change = -$6,000 / 0.08 = -$75,000. ($48,000 would wrongly multiply by 8.) The result assumes the cap rate does not change.
Why This Is the Correct Answer
Option C is correct because NOI falls by the $6,000 unreimbursed tax increase, and value equals NOI divided by the cap rate. The change in value is -$6,000 / 0.08 = -$75,000, so value decreases by $75,000, assuming the 8% cap rate does not change.
Why the Other Options Are Wrong
Option A: Increases by $75,000
Option A is wrong because an increase of $75,000 gets the size right but the direction wrong. A higher expense lowers NOI, so -$6,000 / 0.08 = -$75,000 is a decrease, not an increase.
Option B: Decreases by $6,000
Option B is wrong because a decrease of $6,000 is only the change in annual NOI, not the change in value. The NOI change must be capitalized: -$6,000 / 0.08 = -$75,000.
Option D: Decreases by $48,000
Option D is wrong because a decrease of $48,000 comes from multiplying $6,000 by 8 instead of dividing by 0.08. The correct calculation is -$6,000 / 0.08 = -$75,000.
IRV: divide income by rate
In I = R x V, value V equals income I divided by rate R, so a change in income divided by the rate gives the change in value.
How to use: Use this to convert any change in NOI into a change in value at a fixed cap rate.
Exam Tip
When NOI changes and the cap rate stays the same, divide the NOI change by the rate and check the direction: higher expenses mean lower value.
Common Mistakes to Avoid
- -Reporting the $6,000 NOI change as the change in value
- -Multiplying by the cap rate instead of dividing
- -Treating a higher expense as an increase in value
Concept Deep Dive
Analysis
This question tests direct capitalization sensitivity: how a change in net operating income changes indicated value when the cap rate is held constant. A $6,000 tax increase that tenants do not reimburse lowers NOI by $6,000, and dividing that change by the 8% rate gives the change in value.
Background Knowledge
In direct capitalization, value equals net operating income divided by the overall capitalization rate. Because value is NOI divided by the rate, any change in NOI changes value by that amount divided by the rate when the rate is held constant. Real estate taxes are an operating expense, so an unreimbursed increase reduces NOI.
Real-World Application
A small office building's property tax reassessment adds $6,000 per year in expenses that the gross leases do not pass through. Holding the market cap rate at 8%, the appraiser notes the indicated value drops by $75,000.
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