A commercial property generates $120,000 in annual gross rental income and has operating expenses of $35,000. If the property sells for $850,000, what is the CAP rate?

Q: What is the correct answer to: A commercial property generates $120,000 in annual gross rental income and has operating expenses of $35,000. If the property sells for $850,000, what is the CAP rate?

The correct answer is 10.0%. Option A (10.0%) is correct because it properly applies the CAP rate formula. First, calculate NOI: $120,000 gross income minus $35,000 operating expenses equals $85,000. Then divide NOI by property value: $85,000 ÷ $850,000 = 0.10 or 10.0%. This follows standard commercial real estate valuation principles recognized across Canadian jurisdictions and is essential knowledge for licensees dealing with commercial investment properties under provincial real estate legislation.

Q: What background knowledge is needed for this Commercial Real Estate question?

The capitalization rate (CAP rate) is calculated as Net Operating Income divided by property value or purchase price. NOI is gross rental income minus operating expenses (but not debt service or depreciation). CAP rates help investors compare properties and assess risk - higher CAP rates generally indicate higher risk/return properties. In Canada, real estate licensees must understand these calculations when advising clients on commercial investments, as required under provincial legislation like TRESA, RESA, and RECSA. CAP rates vary by property type, location, and market conditions.

Q: What is a good way to remember the answer to this Commercial Real Estate question?

Visualize a triangle with 'CAP' at the top and 'NOI' and 'Value' at the bottom corners. To find CAP rate, cover the top and divide the bottom two (NOI ÷ Value). Remember 'NOI before you GO' - always calculate Net Operating Income first by subtracting operating expenses from gross income. When you see a CAP rate question, immediately draw the triangle mentally. First calculate NOI (gross income minus operating expenses), then divide by property value. The triangle helps you remember the relationship between all three variables.

Q: What exam tip applies to this Commercial Real Estate question?

Always calculate NOI first: gross income minus operating expenses. Then divide NOI by property value. Double-check your decimal placement - CAP rates are typically expressed as percentages between 4-15% for most commercial properties.

Q: How does this Commercial Real Estate concept apply in real world practice?

A commercial real estate licensee is helping an investor client evaluate a small office building. The building generates $180,000 annually in rent with $45,000 in operating expenses, listed at $1.35 million. The licensee calculates the CAP rate: NOI of $135,000 ÷ $1.35M = 10%. This helps the client compare it to similar properties and assess if the asking price reflects market value for the income stream.

Question

Commercial Real EstateInvestment AnalysisMEDIUM

A commercial property generates $120,000 in annual gross rental income and has operating expenses of $35,000. If the property sells for $850,000, what is the CAP rate?

Answer Options

A

10.0%

B

14.1%

C

4.1%

D

12.5%