valuation

capitalization rate

The capitalization rate, or cap rate, is the rate of return used to convert a property's net operating income into an estimate of value in the income approach. The formula is value equals net operating income divided by cap rate, often remembered as IRV: income equals rate times value. A higher cap rate produces a lower value, and a lower cap rate produces a higher value, reflecting perceived risk.

Exam tip: Use net operating income, not gross income or income after debt service. Value and cap rate move in opposite directions.
Example: A building with $60,000 net operating income and an 8% cap rate is valued at 60,000 / 0.08 = $750,000.

1. An 8-unit building rents for $1,100 per unit per month with 5% vacancy. Annual operating expenses are $28,320 (excluding debt service). At an 8% capitalization rate, what is the value?

Answer & explanation

Answer: D. PGI = 8 x $1,100 x 12 = $105,600; less 5% vacancy = $100,320; NOI = $100,320 - $28,320 = $72,000; value = $72,000 / 0.08 = $900,000.

Related terms & state variants

income approach net operating income rate of return return on investment

Sources

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Last verified: 2026-10-23