Which statement best defines the cap rate?

Which statement best defines the cap rate?

• A. The rate of return on equity after debt service.
• B. The tax rate applied to property income.
• C. A rate used to convert NOI into value.
• D. The rate used to calculate internal rate of return.

Answer: (C)

The cap rate is the rate used to convert net operating income into value. In the income capitalization approach, value is found by dividing NOI by the cap rate, so the cap rate represents the return an investor would expect from the property if purchased with cash, without considering financing or taxes. NOI is the annual income after operating expenses but before debt service and taxes, and the cap rate reflects the risk and market conditions surrounding that property. The other statements describe different concepts: a rate of return on equity after debt service relates to levered returns, a tax rate is about taxation, and the rate used to calculate internal rate of return is IRR.

The cap rate is the rate used to convert net operating income into value. In the income capitalization approach, value is found by dividing NOI by the cap rate, so the cap rate represents the return an investor would expect from the property if purchased with cash, without considering financing or taxes. NOI is the annual income after operating expenses but before debt service and taxes, and the cap rate reflects the risk and market conditions surrounding that property. The other statements describe different concepts: a rate of return on equity after debt service relates to levered returns, a tax rate is about taxation, and the rate used to calculate internal rate of return is IRR.