A commercial office building generates $150,000 annual net rent. Using a capitalisation rate of 7.5%, what is the estimated value using the capitalisation approach?

Q: What is the correct answer to: A commercial office building generates $150,000 annual net rent. Using a capitalisation rate of 7.5%, what is the estimated value using the capitalisation approach?

The correct answer is $2,000,000. Option B ($2,000,000) is correct because it applies the capitalisation approach formula accurately: Value = Net Income ÷ Capitalisation Rate. With annual net rent of $150,000 and a cap rate of 7.5% (0.075), the calculation is $150,000 ÷ 0.075 = $2,000,000. This method is recognised under Australian Property Institute valuation standards and is commonly used for commercial property valuations where reliable income streams exist.

Q: What background knowledge is needed for this Valuation question?

The capitalisation approach is one of three primary valuation methods recognised by the Australian Property Institute, alongside the direct comparison and cost approaches. It's particularly suited to income-producing properties like commercial offices, retail centres, and industrial facilities. The capitalisation rate reflects market expectations of return and incorporates risk factors specific to the property type and location. In Australia, commercial property valuations must comply with International Valuation Standards and Australian Property Institute guidelines. The method assumes a stabilised income stream and requires careful selection of appropriate cap rates based on comparable sales and market analysis.

Q: What is a good way to remember the answer to this Valuation question?

Remember 'CAP' - Capitalisation Approach Process: 'Cash flow Annual Payment' divided by 'Cap rate' equals 'Property value'. Think of it as 'How much Cash would I pay for this Annual Payment at this Cap rate?' The formula flows like water: Income flows DOWN (÷) through the cap rate to pool into the property value. When you see capitalisation questions, immediately think 'CAP' and visualise income flowing down through the cap rate. Write the formula: V = I ÷ R, then substitute the numbers. Always divide income BY the cap rate, never multiply.

Q: What exam tip applies to this Valuation question?

Quickly identify capitalisation questions by looking for 'annual net income/rent' and 'cap rate'. Write the formula V = I ÷ R immediately. Convert percentages to decimals (7.5% = 0.075) and divide income by cap rate, not multiply.

Q: How does this Valuation concept apply in Australian real estate practice?

A commercial real estate agent is advising a client considering purchasing an office building in Melbourne's CBD. The building generates $150,000 annual net rent, and comparable sales indicate a 7.5% cap rate for similar properties. Using the capitalisation approach, the agent calculates the property value at $2,000,000, helping the client determine if the asking price of $2.1 million represents good value. This valuation method provides a quick assessment tool for investment decisions and negotiation strategies.

Question

ValuationCapitalisation ApproachMEDIUM

A commercial office building generates $150,000 annual net rent. Using a capitalisation rate of 7.5%, what is the estimated value using the capitalisation approach?

Answer Options

A

$1,875,000

B

$2,000,000

C

$2,250,000

D

$1,125,000