Humber/Ontario Real Estate Course 2 Exam Practice

An investor is evaluating the cap rate for an apartment building purchase. What does the capitalization rate represent?

1. The ratio between the annual net income and the purchase price

2. The annual operating expenses of the property based on its market value

3. The total cash return on investment within the first year

4. The amount of leverage required to purchase the property

5. The expected appreciation of the property over ten years

6. The ratio of gross rental income to property value

The correct answer is: The ratio between the annual net income and the purchase price

The capitalization rate (cap rate) represents the ratio between the annual net income and the purchase price of a property. It is used by investors to quickly evaluate the potential return on investment of a property. A higher cap rate typically indicates a higher potential return, while a lower cap rate suggests a lower potential return. Option B is incorrect because it refers to annual operating expenses based on the property's market value, which is not what the cap rate represents. Option C is incorrect as it mentions the total cash return on investment within the first year, which is different from the cap rate. Option D is incorrect as it states the amount of leverage required to purchase the property, which is not what the cap rate measures. Option E is incorrect as it mentions the expected appreciation of the property over ten years, which is not related to the cap rate. Option F is incorrect as it refers to the ratio of gross rental income to the property value, which is not the definition of the cap rate.