Capitalization Rate
Definition
The capitalization rate (cap rate) is the ratio of a property's net operating income to its sale price, expressed as a percentage. It is used to estimate value and compare profitability of investment properties. Cap Rate = NOI / Value.
Example
An office building generates $80,000 in annual NOI and sold for $1,000,000. Cap rate = $80,000 / $1,000,000 = 8%. If a similar building generates $95,000 in NOI and the market cap rate is 8%, the value = $95,000 / 0.08 = $1,187,500.
Exam Tip
Memorize the IRV formula: I (Income/NOI) = R (Rate/Cap Rate) x V (Value). You can solve for any variable. Remember the inverse relationship: as the cap rate goes down, value goes up. Do not confuse cap rate with interest rate or return on equity.
Related Math Terms
Percentage to Decimal Conversion
Converting a percentage to a decimal involves dividing the percentage value by 100.
IRV Formula
IRV stands for Income, Rate, and Value. It represents the relationship between Net Operating Income (I), Capitalization Rate (R), and Property Value (V).
Net Operating Income (NOI)
Net Operating Income (NOI) is the revenue a property generates after deducting all operating expenses.
Gross Rent Multiplier (GRM)
The gross rent multiplier (GRM) is a quick method for estimating the value of income-producing property by multiplying the property's gross rent by a factor derived from comparable sales. GRM = Sale Price / Gross Rent.
Net Operating Income (NOI)
Net operating income (NOI) is the annual income generated by an income-producing property after deducting operating expenses, but before deducting mortgage payments, income taxes, and depreciation.
Loan Qualification Math
Loan qualification math involves calculating the debt-to-income ratios that lenders use to determine whether a borrower qualifies for a mortgage. The two primary ratios are the front-end (housing expense) ratio and the back-end (total debt) ratio.
Frequently Asked Questions
Test Your Math Knowledge
Practice with exam-style questions to make sure you can apply Capitalization Rate and other math concepts.