Mr. Fury is deciding whether to purchase an office building that he estimates to have operating costs of $750,000 per year, gross potential income of $2,000,000, and a vacancy rate of 10%. A similar property with an NOI of $1,000,000 recently sold for $10,000,000. What is the estimated value of this building?
A)$750,000
B)$1,050,000
C)$2,000,000
D)$10,500,000
E)$11,000,000

Question

Quizplus · Accepted Answer

First, calculate the effective gross income (EGI) by subtracting the vacancy losses from the gross potential income. With a 10% vacancy rate on a $2,000,000 gross potential income, the vacancy losses are $200,000 ($2,000,000 * 10%). So, the EGI is $1,800,000 ($2,000,000 - $200,000). Next, subtract the operating costs of $750,000 from the EGI to find the net operating income (NOI), which is $1,050,000 ($1,800,000 - $750,000). Given that a similar property with an NOI of $1,000,000 sold for $10,000,000, we can use the capitalization rate (cap rate) from this sale to estimate the value of Mr. Fury's building. The cap rate is $1,000,000 / $10,000,000 = 0.1 or 10%. Applying this cap rate to Mr. Fury's building NOI of $1,050,000 gives an estimated value of $10,500,000 ($1,050,000 / 0.1).

Mr Fury Is Deciding Whether to Purchase an Office Building