A sophisticated investor is analyzing a commercial property that shows a Net Operating Income of $120,000. Recent comparable sales indicate cap rates ranging from 5.5% to 7.0%. Economic uncertainty has increased, and the property has some deferred maintenance issues. What cap rate should likely be applied?
Correct Answer
B) 6.5% to 7.0% to reflect increased risk
Higher cap rates reflect higher risk and result in lower valuations. Given the economic uncertainty and deferred maintenance issues, a cap rate toward the higher end of the comparable range (6.5-7.0%) would be appropriate to account for these additional risk factors.
Why This Is the Correct Answer
Cap rates reflect investment risk - higher risk requires higher cap rates to compensate investors. With economic uncertainty and deferred maintenance issues present, the property carries additional risk beyond comparable sales. Using a cap rate toward the higher end of the range (6.5-7.0%) appropriately accounts for these risk factors, ensuring the valuation reflects the property's actual investment risk profile.
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