A buyer purchases a 4-plex. They rent each unit for $1,100 per month and experience a vacancy rate of 5%. Property taxes are $5,500 and annual maintenance is $12,000. If the purchase price is $600,000 what is the buyers capitalization rate?

Rationale

To find the capitalization rate, the correct answer is 6.40%.

The capitalization rate is calculated by dividing the net operating income (NOI) by the property's purchase price. In this case, after accounting for the vacancy rate and expenses, the NOI results in a capitalization rate of 6.40%.

A (5.40%) YOUR ANSWER

This choice underestimates the capitalization rate. It suggests a lower net operating income than what is actually calculated from the rental income after accounting for vacancies and expenses. The correct calculations yield a higher NOI, resulting in a higher capitalization rate.

B (6.40%) CORRECT

This is the correct capitalization rate. It is derived from the annual net operating income of the property divided by the purchase price. After accounting for the rental income from the units, the vacancy rate, property taxes, and maintenance costs, the resulting NOI supports this capitalization rate.

C (8.40%) YOUR ANSWER

This option indicates an overly optimistic capitalization rate. It implies that the net operating income is significantly higher than what is calculated after factoring in the vacancy rate and total expenses. This inflated figure does not accurately reflect the property's income potential.

D (8.80%) YOUR ANSWER

Similar to choice C, this option presents an unrealistically high capitalization rate. It suggests a net operating income that disregards the financial impact of vacancies and property expenses. The actual calculations yield a lower, more accurate capitalization rate.

Conclusion

The capitalization rate is a vital metric for evaluating property investments, representing the relationship between net operating income and purchase price. For the 4-plex in question, the correct capitalization rate of 6.40% reflects a realistic assessment of the property’s income potential, taking into account vacancy rates and necessary expenses. Understanding this calculation helps buyers make informed investment decisions.

A buyer purchases a 4-plex. They rent each unit for $1,100 per month and experience a vacancy rate of 5%. Property taxes are $5,500 and annual maintenance is $12,000. If the purchase price is $600,000 what is the buyers capitalization rate?

To find the capitalization rate, the correct answer is 6.40%.

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