Certified Pennsylvania Evaluator Practice Exam

How is the cap rate calculated in real estate?

1. Market Price / Rental Income

2. Sum of income from mortgage, equity, and taxes

3. Total Revenue / Total Expenses

4. Income from property / Total value of property

The correct answer is: Income from property / Total value of property

The capitalization rate, commonly referred to as the cap rate, is a key metric in real estate that helps investors assess the potential return on an investment property. It is calculated by dividing the income generated from the property by the property's total value. This ratio provides a percentage that indicates the expected return on investment, giving investors a straightforward way to evaluate the profitability of a property. When calculating the cap rate, the income considered is usually the net operating income (NOI), which is the income after operating expenses but before financing costs, taxes, and other deductions. The total value of the property is typically its current market value or the purchase price. This method allows potential real estate investors to compare different investment opportunities, as a higher cap rate generally suggests a potentially better return, assuming that all other factors are equal. It helps in understanding the relationship between the income a property generates and its market value, which is crucial in making informed investment decisions.