Property Valuation
Capitalization rate (cap rate) is used in the income approach and is calculated as:
AGross rental income divided by purchase price
BNet operating income divided by value (or sale price)✓ Correct
CEffective gross income divided by operating expenses
DCash flow after debt service divided by equity
Explanation
Cap Rate = Net Operating Income ÷ Value (or Sale Price). It represents the rate of return on a real estate investment based on the income it generates.
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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.
Gross Rent Multiplier (GRM)A quick valuation metric for income properties calculated by dividing the property price by gross annual rental income.
Debt-to-Income Ratio (DTI)A lender's measure of a borrower's monthly debt obligations relative to their gross monthly income, used to evaluate loan eligibility.
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