A commercial property has a gross rental income of $120,000 annually and operating expenses of $45,000. If the capitalization rate is 8%, what is the estimated property value?

Q: What is the correct answer to: A commercial property has a gross rental income of $120,000 annually and operating expenses of $45,000. If the capitalization rate is 8%, what is the estimated property value?

The correct answer is $937,500. Option A ($937,500) is correct because it properly applies the income capitalization formula. First, calculate Net Operating Income (NOI) by subtracting operating expenses from gross rental income: $120,000 - $45,000 = $75,000. Then divide NOI by the capitalization rate: $75,000 ÷ 0.08 = $937,500. This method is the standard approach for valuing income-producing commercial properties and is recognized under Canadian appraisal standards and real estate practice.

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

The income capitalization approach is one of three primary valuation methods (along with sales comparison and cost approaches) used in real estate appraisal. Net Operating Income (NOI) represents the annual income remaining after deducting all operating expenses but before debt service and income taxes. The capitalization rate reflects market-derived rates of return for similar properties and investment risk levels. This method is particularly important for commercial properties where income generation is the primary value driver. Canadian real estate professionals must understand this approach as it's fundamental to investment analysis and is referenced in provincial real estate legislation and professional standards.

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

Think of property valuation like baking a cake: NOI (Net Operating Income) is your main ingredient after removing all the 'bad stuff' (operating expenses) from gross income. The CAP rate is your 'cooking temperature' - you divide your clean ingredient (NOI) by your temperature (CAP rate) to get your final 'cake' (property value). Remember: NOI ÷ CAP = VALUE. When you see income capitalization questions, immediately think 'recipe time' - identify your NOI ingredient first (gross income minus expenses), then divide by your CAP rate temperature to get your property value result.

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

Always calculate NOI first by subtracting ALL operating expenses from gross income, then divide by the cap rate. Double-check that you're dividing NOI by the cap rate, not multiplying. 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 is helping an investor evaluate a small office building for purchase. The building generates $120,000 annually in rental income but has $45,000 in operating expenses including property taxes, insurance, maintenance, and management fees. Using comparable sales data, the agent determines that similar properties in the area are trading at an 8% capitalization rate. By calculating the NOI ($75,000) and applying the cap rate, the agent can advise the investor that the property's estimated market value is $937,500, helping them make an informed offer decision.

Question

Commercial Real EstateInvestment AnalysisMEDIUM

A commercial property has a gross rental income of $120,000 annually and operating expenses of $45,000. If the capitalization rate is 8%, what is the estimated property value?

Answer Options

A

$937,500

B

$1,500,000

C

$1,200,000

D

$562,500