A commercial property produces net annual income of $120,000. If the market capitalisation rate is 8%, what is its value using the income approach?
Correct Answer
C) $1,500,000
Using the income approach, value = net annual income ÷ capitalisation rate: $120,000 ÷ 0.08 = $1,500,000. The income approach is commonly used for investment properties and values a property on its income-producing ability.
Why This Is the Correct Answer
Value = net income ÷ capitalisation rate = $120,000 ÷ 0.08 = $1,500,000.
Why the Other Options Are Wrong
Option A: $1,200,000
$1,200,000 is $120,000 capitalised at 10%, not at the 8% market rate.
Option B: $1,300,000
$1,300,000 implies a capitalisation rate of about 9.2%, higher than the 8% given.
Option D: $1,600,000
$1,600,000 is $120,000 capitalised at 7.5%, a lower rate than the 8% given.
Deep Analysis of This Valuation Question
Comparing this with a 7.5% rate on the same income ($1,600,000) shows how sensitive value is to the rate: half a percentage point moves value by $100,000. That is why valuers support the rate with several sales of comparable investments.
Background Knowledge for Valuation
The income approach capitalises net income at a market-derived rate. Rates reflect risk and growth prospects: a secure, well-located property with a strong tenant usually sells on a lower rate (higher value) than a riskier one.
Memory Technique
Remember DICE: Divide Income by Cap rate Equals value. Think of rolling dice in a casino - you're gambling on income returns. Just like dividing winnings, you Divide the annual Income by the Capitalisation rate to get the property's value.
When you see income approach questions, immediately think DICE. Identify the annual income, find the cap rate, then divide income by cap rate. This prevents confusion with multiplication or other incorrect calculations.
Exam Tip for Valuation
Always write the formula first: Value = Income ÷ Cap Rate. Convert percentages to decimals (8% = 0.08). Double-check your division - income divided BY cap rate, not multiplied.
Real World Application in Valuation
A real estate agent is advising a client considering purchasing a small office building generating $120,000 annually. Comparable properties in the area are selling at 8% cap rates. Using the income approach, the agent calculates the property's value at $1,500,000, helping the client determine if the asking price of $1,450,000 represents good value. This valuation method helps justify the investment decision and supports negotiation strategies.
Common Mistakes to Avoid on Valuation Questions
- •Multiplying income by cap rate instead of dividing
- •Forgetting to convert percentage to decimal
- •Using wrong cap rate from memory instead of given rate
Related Topics & Key Terms
Key Terms:
More Valuation Questions
What is the primary purpose of a Rating Valuation (RV) in New Zealand?
What does the 'highest and best use' principle in property valuation refer to?
Which external factor would most significantly impact property values across an entire suburb?
A valuer is assessing a unique heritage building with no recent comparable sales. The replacement cost is $2,000,000, accumulated depreciation is estimated at $400,000, and the land value is $800,000. What is the indicated value using the cost approach?
Under the Rating Valuations Act 1998, what principle must valuers follow when determining rateable values?
- → What is the primary purpose of Land Value (LV) in New Zealand rating valuations?
- → When using the income approach for valuing a rental property, what is the most critical factor in determining accuracy?
- → A registered valuer is conducting a market analysis for a residential property. Which of the following sales would be considered the most reliable comparable?
- → A commercial property generates annual rental income of $120,000. After deducting operating expenses of $30,000, the net operating income is $90,000. Using a market-derived capitalization rate of 7.5%, what is the indicated value using the income approach?
- → A registered valuer is valuing a unique heritage building with no comparable sales available. The building would cost $2.5 million to construct today, but due to its age and condition, suffers from $800,000 in physical depreciation and $300,000 in functional obsolescence. The land value is assessed at $1.2 million. What is the total property value using the cost approach?
- → Which factor would have the LEAST impact on a residential property's market value?
- → A property's rating valuation shows a capital value of $800,000 and a land value of $500,000. What value of improvements does that imply?
- → A commercial property produces net annual income of $120,000. Using a capitalisation rate of 7.5%, what value does the income approach indicate?
- → When analyzing market trends for valuation purposes, which combination of factors would most strongly indicate a shift from a seller's market to a buyer's market?
- → In the sales comparison approach, which difference calls for an upward adjustment to the comparable's sale price?
People Also Study
Property Law & Legislation
56 questions
Agency Practice
89 questions
Sale & Purchase Process
63 questions
Professional Conduct & Ethics
46 questions
Related Study Resources
Previous Question
A commercial property generates annual rental income of $120,000. After deducting operating expenses of $30,000, the net operating income is $90,000. Using a market-derived capitalization rate of 7.5%, what is the indicated value using the income approach?
Next Question
A property's rating valuation shows a capital value of $800,000 and a land value of $500,000. What value of improvements does that imply?