If net operating income is 120,000 and the cap rate is 6%, what is the estimated value?

If net operating income is 120,000 and the cap rate is 6%, what is the estimated value?

• A. 2,000,000
• B. 200,000
• C. 12,000,000
• D. 20,000

Answer: (A)

Direct capitalization uses the relationship between income a property produces and the rate of return investors require. Value = NOI divided by the cap rate. Convert the cap rate to a decimal (6% = 0.06) and divide: 120,000 ÷ 0.06 = 2,000,000. So the estimated value is 2,000,000. This shows why the value moves inversely with the cap rate: a higher rate would lower value, a lower rate would raise it. The other numbers don’t come from this formula because they would result from multiplying by the rate or misplacing the decimal.

Direct capitalization uses the relationship between income a property produces and the rate of return investors require. Value = NOI divided by the cap rate. Convert the cap rate to a decimal (6% = 0.06) and divide: 120,000 ÷ 0.06 = 2,000,000. So the estimated value is 2,000,000. This shows why the value moves inversely with the cap rate: a higher rate would lower value, a lower rate would raise it. The other numbers don’t come from this formula because they would result from multiplying by the rate or misplacing the decimal.