How is the capitalization rate (cap rate) used when evaluating income properties?

How is the capitalization rate (cap rate) used when evaluating income properties?

• A. Cap rate is calculated by dividing gross operating income by property value.
• B. Cap rate is the multiplication of net operating income by property value.
• C. Net operating income divided by property value; used to estimate value for income properties.
• D. Cap rate determines loan-to-value ratio for a property.

Answer: (C)

The main idea is that the cap rate captures the relationship between income and price for an income property. It is found by dividing net operating income (NOI) by the property's value. This tells you what percentage of the property's value the annual NOI represents. In practice, you can use the cap rate to estimate value: if you know the NOI and a market cap rate for similar properties, you can estimate value as value ≈ NOI ÷ cap rate. The cap rate uses NOI (not gross income or debt service) and ties directly to price, helping you compare properties or gauge what price corresponds to a desired return.

The main idea is that the cap rate captures the relationship between income and price for an income property. It is found by dividing net operating income (NOI) by the property's value. This tells you what percentage of the property's value the annual NOI represents. In practice, you can use the cap rate to estimate value: if you know the NOI and a market cap rate for similar properties, you can estimate value as value ≈ NOI ÷ cap rate. The cap rate uses NOI (not gross income or debt service) and ties directly to price, helping you compare properties or gauge what price corresponds to a desired return.