Income Approach: Net Operating Income, Cap Rate, and Property Value

For a direct-capitalization study problem, value equals annual net operating income divided by the capitalization rate. Identify whether the income is already net, and put the amounts on the same time basis before calculating.

Use the rate as a decimal: 8% = 0.08. This is a simplified valuation exercise. A cap rate is not the mortgage interest rate, and applying a supplied rate does not replace a property appraisal.

Worked example: monthly net income is already given

A practice problem states that a property has monthly net operating income of $4,500 and a capitalization rate of 9%. It separately mentions $1,200 in monthly operating expenses already deducted in arriving at that NOI.

1. Annual NOI: $4,500 × 12 = $54,000.
2. Convert the rate: 9% = 0.09.
3. Value: $54,000 ÷ 0.09 = $600,000.

Do not deduct the $1,200 again. The word “net” and the problem’s explanation tell you the expenses have already been accounted for. If a question uses “net income” without defining it, read the surrounding facts; do not assume cash flow after mortgage payments is NOI.

When gross income is given instead

Suppose annual potential rent is $120,000, combined vacancy and collection loss is 5%, no other income is given, and annual operating expenses are $34,000.

1. Vacancy and collection loss: $120,000 × 0.05 = $6,000.
2. Effective gross income: $120,000 − $6,000 = $114,000.
3. NOI: $114,000 − $34,000 = $80,000.
4. At an 8% cap rate, value is $80,000 ÷ 0.08 = $1,000,000.

Mortgage debt service is not an operating expense in this NOI calculation. Neither is the owner’s income tax or tax depreciation. See Vacancy and Collection Loss: Calculate EGI and NOI.

Check the direction of your answer

With the same NOI, a higher cap rate produces a lower indicated value. At $60,000 annual NOI, an 8% rate indicates $750,000; a 10% rate indicates $600,000. This is a mathematical relationship, not a prediction that income or market rates will stay fixed.

Try three practice questions

1. Annual NOI is $72,000 and the supplied cap rate is 8%. What is indicated value?
2. A property is valued at $800,000 and has annual NOI of $64,000. What is its cap rate?
3. Monthly NOI is $3,000 after operating expenses. At a 6% cap rate, what is indicated value?

Answers and explanations

1. $900,000. $72,000 ÷ 0.08.
2. 8%. $64,000 ÷ $800,000 = 0.08.
3. $600,000. Annual NOI is $36,000; $36,000 ÷ 0.06. Do not deduct expenses twice.

Keep studying

Review how to choose a math formula. Return to the exam-prep guide.

Submit a support request with your course, lesson or practice-question number, and the step you want explained. These are original study exercises, not recalled state-exam questions.