California Real Estate Practice Exam

Which type of capitalization rate would a fire station building probably have compared to a small appliance sales and repair store?

1. Higher

2. Lower

3. Same as

4. Varying; sometimes higher, sometimes lower

The correct answer is: Higher

In real estate, capitalization rates are used to estimate the return on investment for income-producing properties. The capitalization rate is calculated as the ratio of net operating income to the value of the property. A fire station, generally operated by local government and typically not a profit-seeking business, is unlikely to generate substantial income compared to commercial properties like a small appliance sales and repair store. This store, which is structured to generate profit, generally has a higher potential for consistent income. As such, the capitalization rate for the fire station building is probably higher because its income (if any) would be less predictable and lower than that of the appliance store. The lower and more stable income stream from a commercial venture like a small appliance store usually results in a lower capitalization rate. Therefore, the differences in income stability and predictability between public service buildings and profit-driven business establishments explain why a fire station is likely to have a higher capitalization rate.