Question

You have just completed the appraisal of an office building and have concluded that the market value of the property is $2,500,000. You expect Potential Gross Income (PGI) in the first year of operations to be $450,000; vacancy and collection losses to be 9 percent of PGI; operating expenses to be 38 percent of Effective Gross Income (AGI), and capital expenditures to be 4 percent of EGI. What is the implied going-in capitalization rate

Answer 1

Answer:

The implied going-in capitalization rate is 0.10155 = 10.155%

Explanation:

Given:

Potential Gross Income (PGI) = $450,000

The vacancy and collection losses  is 9% of PGI = 9/100 × $450,000 = $40500

Acquisition price = $2,500,000

To calculate the Effective gross income (EGI), we use the formula:

Effective gross income (EGI) = Potential Gross Income (PGI) - vacancy and collection losses

∴ Effective gross income (EGI) = $450000 - $40500 = $409500.

Also to calculate the Net operating income (NOI), we use the equation:

Net operating income (NOI) = Effective gross income (EGI) - Operating expenses (OE)

But Operating expenses (OE) is 38% of Effective Gross Income (AGI)

∴  Operating expenses (OE) = 38/100 × $409500 = $155610

Net operating income (NOI) = $409500 - $155610  = $253890

The overall capitalization rate(R₀) = (Net operating income (NOI)) ÷ (Acquisition price)

R₀ = $253890 ÷ $2500000 = 0.10155 = 10.155%