An apartment building has a potential gross income of $72,000, but a vacancy rate of 10%. Operating expenses average $500 per month. The owner of the building expects a capitalization rate of 8%. What is the value of the property?

Rationale

$735,000

To determine the value of the property, we first need to calculate the effective gross income by accounting for the vacancy rate, which leads to a net operating income that can then be capitalized using the expected capitalization rate.

A ($470,400) YOUR ANSWER

This amount is significantly lower than the correct calculation. It does not accurately reflect the effective gross income after factoring in the vacancy rate and the subsequent calculation of net operating income and property value based on the capitalization rate.

B ($735,000) CORRECT

This is the correct answer. The effective gross income is calculated as $72,000 minus 10% for vacancies, resulting in $64,800. Subtracting the annual operating expenses of $6,000 ($500 per month) gives a net operating income of $58,800. Dividing this by the capitalization rate of 0.08 (8%) yields a property value of $735,000 ($58,800 / 0.08 = $735,000).

C ($803,750) YOUR ANSWER

This value is higher than the calculated property value. It likely results from incorrect assumptions about either the net operating income or the capitalization rate, leading to an overestimation of the property’s worth.

D ($825,000) YOUR ANSWER

This choice also exceeds the correct property value. Similar to option C, this figure suggests a miscalculation in deriving the net operating income or applying the capitalization rate, which should be based on the actual net operating income derived from the effective gross income after expenses.

Conclusion

The accurate valuation of the apartment building, taking into account the vacancy rate and operating expenses, results in a property value of $735,000. This figure is derived from the effective gross income and the net operating income, which are essential for applying the capitalization rate correctly. Understanding these financial metrics is crucial for property valuation in real estate investment.

An apartment building has a potential gross income of $72,000, but a vacancy rate of 10%. Operating expenses average $500 per month. The owner of the building expects a capitalization rate of 8%. What is the value of the property?

$735,000

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