A valuer is assessing a commercial office building that generates $120,000 annual net rental income. If the market capitalisation rate is 8%, what is the indicated value using the capitalisation approach?

Q: What is the correct answer to: A valuer is assessing a commercial office building that generates $120,000 annual net rental income. If the market capitalisation rate is 8%, what is the indicated value using the capitalisation approach?

The correct answer is $1,500,000. Option B ($1,500,000) is correct because it applies the capitalisation approach formula accurately: Value = Net Income ÷ Capitalisation Rate. Substituting the given values: $120,000 ÷ 0.08 = $1,500,000. This method is recognised under Australian valuation standards and reflects how commercial property investors determine value based on income-generating capacity. The 8% capitalisation rate represents the market's required rate of return for this type of investment property.

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 sales comparison and cost approaches. It's specifically designed for income-producing properties where rental income is the primary value driver. The capitalisation rate represents the market's required rate of return and reflects factors including property risk, location, lease terms, and market conditions. Under Australian valuation standards, registered valuers must consider market evidence when selecting appropriate capitalisation rates. This method is particularly important for commercial properties, investment properties, and properties subject to long-term leases. The approach assumes income will continue at current levels and that the capitalisation rate accurately reflects market expectations.

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

Remember 'VIC' - Value equals Income over Cap rate. Think of it as 'Very Important Calculation': V = I ÷ C. Visualise income flowing into a funnel (the cap rate) that determines the final value container size. When you see capitalisation approach questions, immediately write 'V = I ÷ C' and identify the income and cap rate from the question. This prevents confusion with multiplication or other formulas.

Q: What exam tip applies to this Valuation question?

Always convert percentage cap rates to decimals (8% = 0.08) before calculating. Write the formula V = I ÷ C first, then substitute values. Double-check by ensuring your answer makes sense - higher cap rates mean lower values.

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

A commercial real estate agent is helping an investor evaluate a small office building. The building generates $120,000 annually in net rent after expenses. Recent sales of comparable office buildings show investors are accepting 8% returns. Using the capitalisation approach, the agent calculates the property value at $1,500,000, helping the investor understand whether the asking price of $1,600,000 represents good value. This calculation forms the basis for negotiation and investment decision-making.

Question

ValuationCapitalisation_approachMEDIUM

A valuer is assessing a commercial office building that generates $120,000 annual net rental income. If the market capitalisation rate is 8%, what is the indicated value using the capitalisation approach?

Answer Options

A

$1,200,000

B

$1,500,000

C

$1,800,000

D

$960,000