California Real Estate Practice Exam

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An investor is considering buying a vacant property and building a building on it which will cost $170,000. Rental income will be $2,700 per month, and annual expenses will be $8,200. What is the maximum he can pay for the land if he uses an 11% capitalization rate?

$60,000
$50,000
$40,000
$30,000

The correct answer is: $60,000

To determine the maximum amount the investor can pay for the land, we start by calculating the net operating income (NOI), which is essential for using the capitalization rate approach. The rental income totals $2,700 per month, leading to an annual rental income of $32,400 (which is $2,700 times 12 months). Next, we subtract the annual expenses from the annual rental income to find the NOI: Annual Rental Income: $32,400 Annual Expenses: $8,200 Net Operating Income (NOI) = Annual Rental Income - Annual Expenses NOI = $32,400 - $8,200 = $24,200 Now, we apply the capitalization rate to find the maximum value the investor should pay for the property, using the formula: Value = NOI / Capitalization Rate Substituting the values, we have: Value = $24,200 / 0.11 = $220,000 This value of $220,000 represents the total maximum investment for the property, including both the land and the building. Since the cost of the building is $170,000, we can find the maximum price for the land by subtracting the building costs from the total value