How To Calculate Cap Rate & NOI

Q: How do you calculate cap rate for investment property and how is it related to net operating income? Sarah, Cooperstown, NY

A: Let’s first define net operating income and cap rate:

Net operating income (NOI) = (annual operating income)-(annual operating expenses)

Annual operating income generated by a property after deducting operating expenses. Example: income from rents + income from parking + income from vending (washer, dryer, vending machine)
Capitalization (Cap) Rate is the rate of return on real estate investment property based on income the property is expected to generate.

Cap Rate = (Net operating income/property value)

Also, Property Value = Net Operating Income/Cap Rate

Cap rate is used to estimate a real estate investor’s potential return on investment

NOTE: Cap rate changes as property value and net operating income changes (i.e., cap rate rises as property value decreases or net operating income increases and vice versa. Cap rate will be higher if your purchase price is lower)

Thanks for your question, Sarah. For more real estate information and tips visit my blog at geraldlucas.com.