A property has an NOI of $50,000 and a cap rate of 5%. What is the value?
Audio Lesson
Duration: 2:44
Question & Answer
Review the question and all answer choices
$500,000
Answer A ($500,000) is incorrect because it represents the result of multiplying NOI by the cap rate ($50,000 × 0.05 = $2,500) or incorrectly dividing the cap rate by NOI. This demonstrates a misunderstanding of the valuation formula.
$750,000
Answer B ($750,000) is incorrect and appears to be a random figure that doesn't result from any standard calculation with the given numbers. It may tempt students who are unsure of the formula but recognize that the answer should be higher than $500,000.
$1,000,000
$250,000
Answer D ($250,000) is incorrect as it represents half of the correct answer. This might result from incorrectly multiplying the NOI by the cap rate (without converting to decimal) or other calculation errors.
Why is this correct?
Answer C ($1,000,000) is correct because it properly applies the capitalization formula: $50,000 NOI divided by 0.05 cap rate equals $1,000,000. This follows the fundamental valuation principle that property value equals net operating income divided by the capitalization rate.
Deep Analysis
AI-powered in-depth explanation of this concept
The capitalization rate (cap rate) is a fundamental concept in commercial real estate valuation that directly impacts investment decisions. This calculation helps determine property value based on its income potential, making it essential for investors, brokers, and appraisers. The formula Value = NOI ÷ Cap Rate is straightforward but powerful. In this question, we're given a Net Operating Income (NOI) of $50,000 and a cap rate of 5%. By dividing the NOI by the cap rate (expressed as a decimal), we get the property value. This calculation is critical because it standardizes property comparison across different markets and property types. The challenge here isn't the math itself, but understanding what cap rate represents and how it affects value. A lower cap rate indicates higher value relative to income, while a higher cap rate suggests lower value. This question tests whether students can correctly apply the formula and understand the inverse relationship between cap rates and property values.
Knowledge Background
Essential context and foundational knowledge
The capitalization rate is a key metric in real estate investment analysis that represents the relationship between a property's net operating income and its value. It emerged as a standard valuation tool in the mid-20th century as commercial real estate became more investment-oriented. The cap rate reflects both the property's income potential and the investor's required rate of return. Most states, including Arizona, require real estate professionals to understand cap rates when valuing commercial properties or advising investors. Cap rates vary by market, property type, and economic conditions, with higher rates typically indicating higher risk or lower growth expectations.
Think of cap rate as a 'yield percentage' for a property. Just as a $100 investment yielding 5% gives you $5 annually, a property with $50,000 income at 5% cap rate is worth $1,000,000.
When you see cap rate, think 'yield percentage' and remember that value = income ÷ yield percentage
For cap rate questions, remember: Value = NOI ÷ Cap Rate. Always convert the cap rate percentage to a decimal first (5% = 0.05). If the cap rate seems high, the value will be lower, and vice versa.
Real World Application
How this concept applies in actual real estate practice
As a commercial real estate agent in Phoenix, you're listing a small office building. The owner provides financials showing $50,000 in annual net operating income. Market research shows similar properties in the area are selling at a 5% cap rate. Using this formula, you can confidently tell the owner their property is worth approximately $1,000,000. This valuation helps you set an appropriate listing price and justify it to potential buyers who will perform their own due diligence using the same metrics.
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