Canadian Accredited Insurance Broker (CAIB) Two Practice Exam

What approach is used to calculate the actual cash value of a rental property?

1. Subtracting costs for renovations from current market value

2. Determining the net annual rental income and applying a capitalization factor

3. Assessing the original purchase price of the property

4. Summing all previous operational expenses

The correct answer is: Determining the net annual rental income and applying a capitalization factor

The actual cash value (ACV) of a rental property is primarily determined by evaluating the income it can generate. This is commonly achieved by calculating the net annual rental income and applying a capitalization factor. This approach reflects the property's income-generating potential, which is crucial in real estate as it accounts for what investors are likely to pay based on the income that can be derived from the property. By determining the net annual rental income, one identifies the revenue the property produces, while the capitalization factor—which may include the expected return on investment—helps in converting that income stream into a present value. This method effectively gives insight into the property's worth as an investment rather than merely its physical attributes or past costs. In contrast, other methods, such as subtracting renovation costs from current market value or estimating value based solely on the original purchase price or summing operational expenses, do not provide a comprehensive picture of the property's value based on its ongoing revenue potential. The rental income approach incorporates market conditions and demand, which are vital for understanding an investment property's actual cash value.