California Real Estate Broker ExaminationValuation and AppraisalHard
An appraiser is using the Income Approach to value a commercial property. The property has an annual Gross Operating Income (GOI) of $200,000, operating expenses of $80,000, and a vacancy and collection loss allowance of $10,000. If the capitalization rate is 8%, what is the estimated value of the property?
- A$1,375,000
- B$1,500,000
- C$2,500,000
- D$1,750,000
Show answer & explanationAnswer & explanation
Correct answer: A. $1,375,000
First, calculate the Net Operating Income (NOI). NOI = GOI - Vacancy/Collection Loss - Operating Expenses. NOI = $200,000 - $10,000 - $80,000 = $110,000. Then, Value = NOI / Capitalization Rate. Value = $110,000 / 0.08 = $1,375,000.
Why the other options are wrong
- B. This would be the value if operating expenses were incorrectly excluded from the NOI calculation: ($200,000 - $10,000) / 0.08 = $1,875,000 (error in calculation for this option based on explanation).
- C. This would be the value if only GOI was used, ignoring all expenses and vacancy: $200,000 / 0.08 = $2,500,000.
- D. This would be the value if only operating expenses were subtracted from GOI, ignoring vacancy: ($200,000 - $80,000) / 0.08 = $1,500,000 (error in calculation for this option based on explanation).
Income Approach (Capitalization)
The Income Approach estimates a property's value by converting its expected future income into a present value, typically using a capitalization rate.
- Primarily used for income-producing properties.
- Formula: Value = Net Operating Income (NOI) / Capitalization Rate.
- Requires accurate estimation of income, expenses, and cap rate.
Memory trick: Income Approach: Net Income OVER Cap Rate equals VALUE.