How is value derived from net operating income and the cap rate?

How is value derived from net operating income and the cap rate?

• A. value = cap rate ÷ NOI
• B. value = NOI × cap rate
• C. value is independent of cap rate
• D. value = NOI ÷ cap rate

Answer: (D)

In the income approach, value is found by dividing the net operating income by the cap rate. The cap rate represents the return investors expect for that property, reflecting risk and market conditions, while NOI is the annual income left after operating expenses. Since cap rate equals NOI divided by value, rearranging gives value = NOI ÷ cap rate. This means higher NOI increases value, and a lower cap rate (lower required return) also increases value; conversely, a higher cap rate lowers value. For example, if NOI is 100,000 and the cap rate is 8% (0.08), value = 100,000 ÷ 0.08 = 1,250,000. The other formulas don’t fit the relationship: dividing cap rate by NOI doesn’t yield value, and multiplying NOI by the cap rate would not produce a property's price. Value clearly depends on the cap rate, changing inversely with it.

In the income approach, value is found by dividing the net operating income by the cap rate. The cap rate represents the return investors expect for that property, reflecting risk and market conditions, while NOI is the annual income left after operating expenses. Since cap rate equals NOI divided by value, rearranging gives value = NOI ÷ cap rate. This means higher NOI increases value, and a lower cap rate (lower required return) also increases value; conversely, a higher cap rate lowers value.

For example, if NOI is 100,000 and the cap rate is 8% (0.08), value = 100,000 ÷ 0.08 = 1,250,000.

The other formulas don’t fit the relationship: dividing cap rate by NOI doesn’t yield value, and multiplying NOI by the cap rate would not produce a property's price. Value clearly depends on the cap rate, changing inversely with it.