Florida Real Estate Broker Exam — All Questions

Net operating income for an investment property is found by subtracting from effective gross income:

• a.Operating expenses, debt service, and depreciation
• b.Operating expenses and debt service together
• c.Debt service, but not operating expenses
• d.Operating expenses, but not debt service✓

Net operating income measures the earning power of the property itself, independent of how any particular owner financed it, so it is effective gross income less operating expenses only. Debt service is excluded because it varies with the buyer's loan rather than the property, and depreciation is excluded because it is a tax accounting entry rather than a cash expense. That is precisely what makes net operating income comparable across properties and suitable for capitalization. Subtracting annual debt service from net operating income produces before-tax cash flow, which is the figure that describes the individual investor's return.

Under a triple net lease, the tenant pays base rent plus:

• a.Property taxes and insurance, but not maintenance
• b.Property taxes, insurance, and maintenance✓
• c.A stated percentage of gross sales above a breakpoint
• d.Only the utilities the tenant actually consumes

In a triple net lease the tenant pays base rent and also bears the three named property charges: real estate taxes, insurance, and maintenance, which is what the three nets refer to. The structure shifts operating cost risk to the tenant and is common in single-tenant commercial property. A lease covering only taxes and insurance is a double net lease. A lease measuring rent as a percentage of gross sales above a stated breakpoint is a percentage lease, typical of retail. A gross lease, by contrast, has the landlord pay the operating expenses out of the rent collected.

A Florida rental property produces net operating income of $48,000 and carries annual debt service of $33,000. Before-tax cash flow is:

• a.$48,000
• b.$33,000
• c.$81,000
• d.$15,000✓

Before-tax cash flow is net operating income minus annual debt service, so $48,000 minus $33,000 leaves $15,000. The $48,000 figure is the net operating income itself, which ignores the mortgage payments the owner actually makes and therefore overstates what reaches the owner's pocket. The $33,000 figure is the debt service alone. The $81,000 figure adds the two rather than subtracting, which no measure of return would do. If the owner's initial cash investment were known, dividing this $15,000 by that equity would give the cash-on-cash return.

An investor pays $850,000 for a property producing net operating income of $68,000. The capitalization rate is:

• a.12.5 percent
• b.8 percent✓
• c.6 percent
• d.0.8 percent

The capitalization rate is net operating income divided by value, so $68,000 divided by $850,000 equals 0.08, or 8 percent. The 12.5 percent figure inverts the fraction, dividing value by income, which yields the number of years of income needed to equal the price rather than a rate. The 0.8 percent figure is the right division with a misplaced decimal. Keep the relationships straight: value equals income divided by rate, income equals value times rate, and rate equals income divided by value, so for a given income a higher capitalization rate always implies a lower value.