How to Calculate Capitalization Rate (Cap Rate)
The capitalization rate is used in the income approach to value an income-producing property. It ties together Income, Rate and Value — the IRV triangle (I = R × V) — so covering the unknown gives you the right formula.
Formula
Cap rate = Net operating income (NOI) ÷ Value Value = NOI ÷ Cap rate NOI = Value × Cap rate (NOI = effective gross income − operating expenses; it does NOT subtract the mortgage.)
Worked example
An investment property has an NOI of $24,000 and the market cap rate is 8%.
• Value = 24,000 ÷ 0.08 = $300,000
Check it back: at $300,000 and 8% → NOI = 300,000 × 0.08 = $24,000, and 24,000 ÷ 300,000 = 8%. ✓
Key points
- NOI excludes debt service (the mortgage payment) and income taxes — only operating income minus operating expenses.
- Use the IRV triangle: cover the unknown to get I = R × V, V = I ÷ R, or R = I ÷ V.
- A higher cap rate generally means a lower value (and higher perceived risk) for the same income.
Common mistakes
- Subtracting the mortgage payment when computing NOI (it should not be subtracted).
- Dividing when you should multiply — use the IRV triangle to choose the operation.
- Confusing cap rate with the gross rent multiplier (GRM uses gross rent and price, not NOI).
When you use it
The income approach and cap-rate math appear in valuation and investment questions on the national exam.