Question

A property was purchased for $4,500,000.00 and earns a rental income of $50,000.00 per month. Mr. Johnson, the owner, has to pay annual property tax of 1% of value, grounds maintenance fee of 0.2% of value and a common area lighting and maintenance fee of $46,000.00 per annum. A slightly larger property on the same block is now up for sale and the current tenants are paying a monthly rental of $55,000.00. Mr. Johnson has ascertained that the expenses ratio for properties in the area is constant. He wants to purchase this new property and has now asked you to use the income capitalisation approach to real estate valuation to advise him on the following.

(a) What is the annual capitalisation rate that this property will attract?
(b) What is the maximun amount that he should pay for this property given that he does not want to pay more than it is valued?
(c) How many years will it take for the net income to cover the purchase price of the new building?

Answer 1

The annual capitalization rate for the new property can be calculated by dividing the net operating income by the purchase price of the property.

Step-by-step explanation:

The annual capitalization rate for the new property can be calculated by dividing the net operating income by the purchase price of the property. The net operating income can be calculated by subtracting the expenses from the rental income. In this case, the net operating income would be $55,000 - ($55,000 * 0.01) - ($55,000 * 0.002) - $46,000 = $4,170.80 per month or $50,049.60 per year.

Therefore, the annual capitalization rate would be $50,049.60 / purchase price.

To calculate the maximum amount Mr. Johnson should pay for the new property, he needs to divide the annual net income (rental income - expenses) by the annual capitalization rate.

The number of years it will take for the net income to cover the purchase price of the new building can be calculated by dividing the purchase price by the net income.