A commercial property generates $120,000 in annual rental income and has operating expenses of $35,000. If the capitalization rate is 8%, what is the estimated property value?

Q: What is the correct answer to: A commercial property generates $120,000 in annual rental income and has operating expenses of $35,000. If the capitalization rate is 8%, what is the estimated property value?

The correct answer is $1,062,500. Option A correctly applies the income capitalization formula: Property Value = NOI ÷ Cap Rate. First, calculate NOI by subtracting operating expenses from gross rental income: $120,000 - $35,000 = $85,000. Then divide the NOI by the capitalization rate: $85,000 ÷ 0.08 = $1,062,500. This method is recognized under Canadian appraisal standards and provides a market-based valuation approach for income-producing commercial properties.

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

The income capitalization approach is one of three primary valuation methods recognized in Canadian real estate appraisal, alongside the direct comparison and cost approaches. Net Operating Income (NOI) represents the property's annual income after deducting operating expenses but before debt service and taxes. The capitalization rate reflects market expectations for return on investment and varies by property type, location, and market conditions. This method is governed by Canadian appraisal standards and is essential for commercial real estate transactions under provincial legislation like TRESA in Ontario.

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

Remember 'NOI over CAP gives you the MAP' - Net Operating Income divided by CAPitalization rate gives you the MArket Price. Think of it like a fraction: NOI sits on top (numerator) and CAP rate sits below (denominator), just like a building sits on top of its foundation. When you see income capitalization questions, immediately identify the NOI (subtract expenses from income first), then divide by the cap rate. Visualize the fraction with NOI on top and cap rate on bottom to avoid calculation errors.

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

Always calculate NOI first by subtracting operating expenses from gross income, then divide by the cap rate. Double-check that you're using decimals for percentages (8% = 0.08). Watch for answer choices that use gross income instead of NOI.

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

A commercial real estate agent representing an investor client needs to quickly assess whether a listed office building is fairly priced. The property generates $200,000 annually with $60,000 in operating expenses, and comparable properties sell at 7% cap rates. Using NOI of $140,000 ÷ 0.07 = $2,000,000, the agent can advise whether the $1,850,000 asking price represents good value, helping the client make an informed investment decision.

Question

Commercial Real EstateInvestment AnalysisMEDIUM

A commercial property generates $120,000 in annual rental income and has operating expenses of $35,000. If the capitalization rate is 8%, what is the estimated property value?

Answer Options

A

$1,062,500

B

$1,375,000

C

$1,500,000

D

$1,937,500