Question

You are considering purchasing an office building for $1,800,000. You expect the potential gross income (PGI) in the first year of operations to be $350,000; vacancy and collection losses to be 7 percent of PGI; and operating expenses and capital expenditures to be 35 percent of effective gross income (EGI). What is the implied first year overall capitalization rate

a) 9.50%
b) 10.26%
c) 10.49%
d) 11.75%
e) 13.20%

Answer 1

D) 11.75%

Step-by-step explanation:

The overall capitalization rate is calculated by dividing net income by the fair market value of the asset.

net income = effective gross income - operating expenses

effective gross income = potential gross income - vacancy and collection losses = $350,000 - ($350,000 x 7%) = $325,500

net income = $325,500 - ($325,500 x 35%) = $211,575

capitalization rate = $211,575 / $180,000 = 11.75%