A rental property earns $500 a week in rent. Capitalising the gross annual rent at 5%, what is the approximate value?
Correct Answer
B) $520,000
Annual rent = $500 × 52 = $26,000. Capitalised at 5%: $26,000 ÷ 0.05 = $520,000. Because this uses gross rent, the 5% must be a gross yield analysed from sales on the same basis.
Why This Is the Correct Answer
Annual rent = $500 × 52 = $26,000; $26,000 ÷ 0.05 = $520,000.
Why the Other Options Are Wrong
Option A: $260,000
$260,000 capitalises the annual rent at 10%, double the 5% rate given.
Option C: $650,000
$650,000 capitalises the annual rent at 4%, below the 5% rate given.
Option D: $780,000
$780,000 is 30 times the annual rent, which implies a rate of about 3.3%.
Deep Analysis of This Valuation Question
This question tests understanding of the income approach to property valuation, a fundamental method used for investment properties in New Zealand. The income approach calculates property value based on the income it generates, using the formula: Property Value = Annual Net Income ÷ Capitalization Rate. This method is particularly relevant for rental properties where income generation is the primary purpose. The capitalization rate (cap rate) reflects the expected rate of return and incorporates factors like risk, market conditions, and property type. In New Zealand's property market, this approach is essential for investors, valuers, and real estate agents when assessing investment properties. Understanding this calculation is crucial for REA licensing as agents must provide accurate market advice to clients considering investment purchases or sales.
Background Knowledge for Valuation
For residential rentals, investors often talk in gross yields: annual rent divided by price. A gross yield must be applied to gross rent. If a net yield is used instead, outgoings such as rates, insurance and maintenance must be deducted from the rent first.
Memory Technique
Remember RICE: Rent × 52 ÷ Interest = Capital value. Like cooking rice, you need the right proportions - weekly Rent multiplied by 52 weeks, then divided by the Interest rate (cap rate) to get your Capital value.
When you see income approach questions, immediately think RICE. Identify the weekly rent, multiply by 52, then divide by the cap rate percentage (as a decimal). This systematic approach prevents calculation errors.
Exam Tip for Valuation
Always convert weekly rent to annual first ($500 × 52 = $26,000), then divide by cap rate as decimal (5% = 0.05). Double-check by working backwards: $520,000 × 0.05 = $26,000 annual rent.
Real World Application in Valuation
A real estate agent represents a client considering purchasing a rental property in Auckland. The property generates $500 weekly rent, and comparable properties show a 5% cap rate. Using the income approach, the agent calculates the property's investment value at $520,000, helping the client determine if the asking price of $550,000 represents good value. This analysis supports the client's investment decision and demonstrates the agent's professional competence in property valuation principles.
Common Mistakes to Avoid on Valuation Questions
- •Forgetting to convert weekly rent to annual rent
- •Using cap rate as whole number instead of decimal (5 instead of 0.05)
- •Multiplying instead of dividing by the cap rate
Related Topics & Key Terms
Key Terms:
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- → What is the primary purpose of Land Value (LV) in New Zealand rating valuations?
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A registered valuer is valuing a unique heritage building with no comparable sales. The building generates $80,000 annual rental income, but the cost to replace it would be $2.5 million, while the land is worth $500,000. If the appropriate capitalisation rate is 6.5%, which approach would likely provide the most reliable value indication?
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A valuer is assessing a property where the land value is $400,000 and the depreciated replacement cost of improvements is $350,000. What would be the total property value using the cost approach?