California Real Estate Broker ExaminationValuation and AppraisalMedium
A commercial property has an effective gross income of $150,000 and operating expenses of $60,000. If the capitalization rate for similar properties in the area is 10%, what is the estimated value of the property using the income approach?
- A$2,100,000
- B$1,500,000
- C$600,000
- D$900,000
Show answer & explanationAnswer & explanation
Correct answer: D. $900,000
The income approach uses Net Operating Income (NOI). NOI = Effective Gross Income - Operating Expenses = $150,000 - $60,000 = $90,000. Property Value = NOI / Capitalization Rate = $90,000 / 0.10 = $900,000.
Why the other options are wrong
- A. Incorrect, adds EGI and Operating Expenses before dividing.
- B. Incorrect, uses EGI directly ($150,000 / 0.10 = $1,500,000) instead of NOI.
- C. Incorrect, uses only operating expenses or a miscalculation.
Income Approach (Capitalization)
The income approach estimates the value of income-producing property by converting its expected future income stream into a present value, using a capitalization rate.
- Formula: Value = Net Operating Income (NOI) / Capitalization Rate.
- Net Operating Income (NOI) is Effective Gross Income minus Operating Expenses.
- Primarily used for commercial and investment properties.
Memory trick: N-O-I over Cap Rate gets you Value, like a 'N-O-I-C' value.