A commercial property has an annual 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 an annual 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 it properly applies the capitalization rate formula. Cap Rate = NOI ÷ Purchase Price = $120,000 ÷ $1,500,000 = 0.08 = 8.0%. This calculation follows standard commercial real estate valuation principles recognized across Canadian jurisdictions. The cap rate represents the annual return an investor would receive if the property were purchased with cash, making it a critical metric for investment decision-making and property comparison.

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

The capitalization rate is calculated as Net Operating Income divided by property value or purchase price, expressed as a percentage. NOI represents the property's annual income after operating expenses but before debt service and taxes. Cap rates are market-driven indicators that reflect investor expectations, risk assessment, and market conditions. In Canadian commercial real estate, understanding cap rates is essential for compliance with professional standards under provincial regulations like TRESA (Ontario), RESA (Alberta), and BCFSA guidelines. Cap rates help determine property values, compare investments, and assess market trends across different commercial property types.

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

Remember 'CAP' as 'Cash Annual Percentage': Cash (NOI) divided by Asset Price equals the annual Percentage return. Think of it like a bank account - if you put $1,500,000 in and get $120,000 back annually, that's your percentage return. When you see cap rate questions, immediately identify the NOI (annual cash flow) and the property value/price. Set up the fraction with NOI on top, property value on bottom, then convert to percentage.

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

Always identify NOI first, then the property value. Set up the division as NOI ÷ Value and convert to percentage. Double-check by ensuring your answer seems reasonable for commercial property returns (typically 4-12%).

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. The property generates $120,000 in NOI annually and is listed for $1,500,000. By calculating the 8.0% cap rate, the agent can compare this opportunity to similar properties in the market and help the client determine if the asking price reflects fair market value. This analysis is crucial for investment recommendations and satisfies professional due diligence standards.

Question

Commercial Real EstateInvestment AnalysisMEDIUM

A commercial property has an annual NOI of $120,000 and was purchased for $1,500,000. What is the capitalization rate?

Answer Options

A

6.0%

B

7.5%

C

8.0%

D

12.5%