Sample test #2 question 74 modern real estate textbook page 505
Vested
🗣️In one commercial building, a tenant intends to start a small health food shop. An identical, adja- cent building houses a showroom leased to a major national retailing chain. Both tenants have long- term leases with identical rents. If the appraiser uses a capitalization rate for the store leased to the national retailing chain that is lower than the rate for the other building, which statement is TRUE? A. The indicated value of the chain's property will be lower than the indicated value of the food-shop property. B. The indicated value of the chain's property will be higher than the indicated value of the food-shop property. C. The appraiser would then be compelled to make use of the sales comparison approach to value. D. It would indicate the appraiser believes a building occupied by a chain-store tenant is more valuable than an identical one occupied by a health food shop.
why is the answer A?
Answers
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Hi Vinita,
A Capitalization Rate is used to estimate the investor's potential return on their investment in the Real Estate market.
The Cap Rate is calculated by dividing a property's net operating Income by its current market value. The Cap Rate is expressed as a percentage and provides an estimation of an investor's potential return on a Real Estate investment. It is most useful for comparing the relative value of similar Real Estate investments.
If a Cap Rate was lowered, and the income remained the same, well then, because a Cap Rate is a ratio of income and current property value, then the value would be lowered.
If both properties had the same value, and one property had a lower Cap Rate, that would mean that the property with the lower Cap Rate would have a lower net income.
I have seen this same question before, but it was worded differently. Theoretically, the major National chain store would have a higher net income versus a small health food store that is just starting out, which would result in a higher Cap Rate.Anthony
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bobratahan Licensing, California Licensing Career Launcher, California Licensing, Buyer Agency Professional (BAP) Posts: 404Moderator
🚨@Vinita11014982 I going to invite other instructors to chime in here. First if we don't have the net income in reality we can't figure out the value of either property. Assuming they are the same, the lower the rate indicates a lower risk, therefore raising the value of the food-chain property. I believe there is something I am missing or the answer is incorrect.
You are not alone wondering why the answer choice is A.
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Hi Vinita,
A Capitalization rate is used to estimate the investor's potential return on their investment in the real estate market.
A Capitalization Rate is calculated by dividing a property's net operating income by its current market value. The Cap Rate is expressed as a percentage and provides an estimation of an investors potential return on a Real Estate investment. It is most useful for comparing the relative value of similar Real Estate investments.
If a Cap Rate was lowered, and the net operating income remained the same, well then, because a Cap Rate is a ratio between the net operating income and the current property value, the value would go up.
If two properties were of equal value, and one property had a lower Cap Rate, the property with the lower cap rate would have a lower net operating income, and vice versa, the property with a higher Cap Rate (both properties being of equal value) would have a higher net operating income.
I have seen this question before, but it was worded differently. The net operating income of a major National retail chain would have a higher net operating income versus a newly established health food store. Therefore, if both units were of the same value, then a higher Cap Rate would be assigned to the major National retail chain store.
In regard to this particular question, despite the assumption that the major National retail chain store has a higher net operating income, the fact that an appraiser assigned a lower Cap Rate to it, the value of this space would be lower than that of the newly established health food store.
This is just a random question.
After thinking about this, the question does not state the NOI for either Store. The only way the correct answer could be A), is if the NOI of the major National retail chain was higher than that of the health food store.
If a lower Cap Rate was assigned to a business, that would result in a lower NOI, or a higher property value.
Seeing as the question states that a lower Cap Rate was assigned to the major National retail chain store, and the correct answer was A) The indicated value of the chain's property will be lower, then the major National chain store would have to have a higher NOI.1 -
Hi Bobra
Assuming the NOI is the same for both properties, if a lower Cap Rate is assigned to the major National retail chain store, the value of that space would be higher and the value of the health food store (higher Cap Rate) would be lower.
Edit: Capitalization is very complex.1 -
bobratahan Licensing, California Licensing Career Launcher, California Licensing, Buyer Agency Professional (BAP) Posts: 404
Moderator
🚨@Anthony My name is Bobra.Your first statement is incorrect. If the NOI is the same the and the rate is lower the value would be higher. Example:
8% $10,000 $83,333
10% $10,000 $100,000
12% $10,000 $125,000
RATE NOI VALUE
The rate not only gives us the return on/of your investment it establishes the RISK involved in the investment. The higher the risk the higher the rate. Just like a loan if you are marginal you pay a higher rate because you are a bigger risk.
.
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Thank you all for taking the time to answer this question. I’m still very fuzzy on the answer. Both properties are identical and both have the same rent, yet the appraiser gave the retail chain a lower cap rate. As Bobra indicated with his figures, the value rises as the cap rate falls so my answer was B. I’m taking my exam this week and I hope that this question is not on the test! Wish me luck, V
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Howard Harris California Licensing Career Launcher, California Licensing, Buyer Agency Professional (BAP) Posts: 425Moderator
🚨Bobra is an ace at math, so trust her here. With identical rents, and assumed identical NOIs, the lower cap rate will increase the value of the property. There is an inverse relationship between cap rate and value, if one goes up the other goes down.
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Thank you all again! You are all very kind! V
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@bobra You are right. The correct answer that was given threw me off 180 degrees. This is kind of a mind bender. Would you elaborate on your numbers, they don't compute for me:
08% $10,000 $83,333
10% $10,000 $100,000
12% $10,000 $125,000
A Cap Rate is obtained by dividing the NOI by a property's current market value. Using a desired Cap Rate to estimate a property's value would be obtained by dividing the NOI by the Cap Rate. Here is what I come up with:
08% $10,000 $125,000
10% $10,000 $100,000
12% $10,000 $8,333
The NOI is the same for all three, but the NOI with the lower Cap Rate results in a lesser valued property.
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bobratahan Licensing, California Licensing Career Launcher, California Licensing, Buyer Agency Professional (BAP) Posts: 404
Moderator
🚨@Vinita11014982 Don't feel discouraged. You had the right answer. One thing I would suggest is please do not study the day before your exam. Do something that brings you joy…relax, have lunch with a friend or whatever. Your brain needs to rest so it is ready for test day. Wishing you the very best. Please let us know you passed your exams.
Bobra G. Tahan (She/Her)
Instructor
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Howard Harris California Licensing Career Launcher, California Licensing, Buyer Agency Professional (BAP) Posts: 425
Moderator
🚨Yes, and that would indicate an answer of D
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bobratahan Licensing, California Licensing Career Launcher, California Licensing, Buyer Agency Professional (BAP) Posts: 404
Moderator
🚨@Anthony You are correct. I had them in the wrong order. This is the correct order.
12% $10,000 $83,333
10% $10,000 $100,000
8% $10,000 $125,000
RATE INCOME VALUE
As the rate goes up the value goes down
As the rate goes down the value goes up
If the income remains the same.
Bobra Tahan-Instructor
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This was a learning experience for me. Thank you for posting, and thank you to Kaplan for being here.
Anthony1 -
I made a mistake on my comment 3 comments up, and now I cannot edit it to fix it.
This is how I meant to write it:08% $10,000 $125,000
10% $10,000 $100,000
12% $10,000 $83,333
The NOI is the same for all three, but the NOI with the lower Cap Rate results in a higher valued property.
I think with practice, this will get easier.
Thank you all again.Anthony
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