A commercial property has a Net Operating Income (NOI) of $120,000 and was purchased for $1,500,000. What is the capitalization rate?

Q: What is the correct answer to: A commercial property has a Net Operating Income (NOI) of $120,000 and was purchased for $1,500,000. What is the capitalization rate?

The correct answer is 8.0%. Option C (8.0%) is correct because the capitalization rate formula is NOI divided by property value. Using the given figures: $120,000 (NOI) ÷ $1,500,000 (purchase price) = 0.08 = 8.0%. This is a straightforward mathematical calculation that follows the standard cap rate formula used throughout the commercial real estate industry. The result indicates this property generates an 8% return based on its Net Operating Income relative to its purchase price.

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

The capitalization rate is a key valuation metric in commercial real estate, calculated as Net Operating Income divided by property value. NOI represents annual rental income minus operating expenses (excluding debt service and depreciation). Cap rates help investors compare properties, determine fair market value, and assess investment returns. They vary by property type, location, and market conditions. Lower cap rates typically indicate lower risk, higher-quality properties or strong markets, while higher cap rates suggest higher risk or emerging markets. This concept is fundamental to the income approach to valuation, one of three primary appraisal methods recognized in Canadian real estate practice.

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

Remember 'CAP' as 'Cash After Purchase': the cap rate shows what percentage of your purchase price comes back as cash (NOI) each year. Think of it like a savings account - if you put $1,500,000 in and get $120,000 back annually, that's your 'interest rate' or cap rate. When you see cap rate questions, immediately identify the NOI and property value, then think 'Cash After Purchase' - divide the annual cash (NOI) by the purchase price to get your percentage return.

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

For cap rate calculations, always divide NOI by property value. Double-check your decimal placement - $120,000 ÷ $1,500,000 = 0.08 = 8.0%. Watch for questions that might reverse the formula or 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 client evaluate a small office building. The property generates $120,000 in NOI and is listed for $1,500,000. By calculating the 8.0% cap rate, the agent can compare this to similar properties in the market. If comparable buildings are trading at 7.5% cap rates, this property might be overpriced. If the market average is 8.5%, this could represent a good value. The cap rate helps the agent advise whether the client should pursue the investment or negotiate the price.

Question

Commercial Real EstateInvestment AnalysisABEASY

A commercial property has a Net Operating Income (NOI) of $120,000 and was purchased for $1,500,000. What is the capitalization rate?

Answer Options

A

6.5%

B

7.2%

C

8.0%

D

8.5%