Capitalization Rate (or “cap rate”) is a ratio used to calculate the value of an investment by looking at the annual net operating income as a percentage of the property’s cost. Cap rate is calculated as Net Income divided by Current Market Value.

For Example: If a building is worth $1,000,000 and has a net operating income of $100,000, then the cap rate is 10% (100,000 divided by 1,000,000.)

You can also use this formula to calculate the value of a property.

Since Cap rate = Net Income / Market Value,
then Market Value = Net Income / Cap Rate.

Thus, if an investor wants a cap rate of 11% on a building that’s generating $80,000 in net operating income, we would value it at $727,272 ($80,000 divided by 0.11)