CFA Level II ExamEquity InvestmentsEasy
A real estate analyst is valuing a portfolio of income-generating properties using various income capitalization techniques. One property, 'Urban Plaza', is expected to generate a Net Operating Income (NOI) of $1,200,000 next year. The analyst has determined a capitalization rate (cap rate) of 6.0% for similar properties in the same market. What is the estimated value of Urban Plaza using the direct capitalization method?
- A$21,000,000
- B$20,000,000
- C$19,200,000
- D$18,000,000
Show answer & explanationAnswer & explanation
Correct answer: B. $20,000,000
The direct capitalization method values a property by dividing its expected Net Operating Income (NOI) for the next year by an appropriate capitalization rate (cap rate). Value = NOI1 / Cap Rate = $1,200,000 / 0.06 = $20,000,000.
Why the other options are wrong
- A. This results from an incorrect calculation, possibly dividing by a lower cap rate or an arithmetic error.
- C. This results from an incorrect calculation or using a wrong cap rate.
- D. This results from an incorrect calculation, possibly dividing NOI by a higher cap rate or multiplying by 0.06.
Direct Capitalization Method (Real Estate)
A real estate valuation method that estimates a property's value by dividing its first-year Net Operating Income (NOI) by a market-derived capitalization rate (cap rate).
- Value = NOI1 / Cap Rate.
- Assumes stable, perpetual income stream.
- Cap rate reflects market expectations for return and growth.
Memory trick: Direct Cap: NOI Over Cap Rate.