Property Valuation
The capitalization rate (cap rate) in the income approach is used to:
ACalculate the gross rent multiplier
BConvert net operating income into an estimate of value✓ Correct
CDetermine the replacement cost of improvements
DCalculate physical depreciation
Explanation
The cap rate converts net operating income (NOI) into a value estimate using the formula: Value = NOI ÷ Cap Rate. A higher cap rate indicates higher risk and lower value for the same NOI.
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Key Terms to Know
Capitalization Rate (Cap Rate)
A rate used to estimate the value of income-producing property, calculated as Net Operating Income divided by property value.
Net Operating Income (NOI)The annual income generated by an income-producing property after subtracting operating expenses, but before debt service.
DepreciationA reduction in the value of an improvement (building) over time due to physical deterioration, functional obsolescence, or external factors.
Gross Rent Multiplier (GRM)A quick valuation metric for income properties calculated by dividing the property price by gross annual rental income.
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