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CFA Level I · CFA Level I Exam · Real Estate and Infrastructure

A property has a gross potential rental income of 1,000,000, vacancy and collection losses of 10% of that income, and operating expenses of 300,000. Using a cap rate of 8%, the property value using the direct capitalization approach is closest to:

The value is about 7,500,000. Net operating income is 900,000 after a 10% vacancy loss, less 300,000 of expenses, giving 600,000. Dividing by the 8% cap rate gives 7,500,000. Ignoring vacancy would overstate value at 8,750,000.

  1. A7,500,000Correct
  2. B8,750,000
  3. C11,250,000

Explanation

Effective income = 1,000,000 × 0.90 = 900,000. NOI = 900,000 − 300,000 = 600,000. Value = 600,000 / 0.08 = 7,500,000. Ignoring vacancy gives 700,000/0.08 = 8,750,000, which is wrong.

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