Certified Apartment Portfolio Supervisor (CAPS) Practice Exam - Module 2

How is the income capitalization rate (cap rate) calculated?

1. Annual NOI divided by total expenses

2. Annual NOI divided by revenue

3. Annual NOI divided by property management fees

4. Annual NOI divided by property value

The correct answer is: Annual NOI divided by property value

The income capitalization rate, commonly referred to as the cap rate, is calculated as the annual net operating income (NOI) of a property divided by the property's current market value. This metric is essential in real estate investment analysis as it allows investors to assess the expected return on an investment property. A high cap rate generally indicates a potentially higher return on investment, while a low cap rate may suggest a lower risk or a property that's in higher demand but potentially lower returns. By focusing on the annual NOI, which reflects the income generated after all operating expenses are deducted, and dividing it by the property value, the cap rate provides a straightforward measure of a property's profitability relative to its cost. The other options do not accurately reflect the formula for cap rate. For instance, dividing NOI by total expenses would not provide relevant insight into the property's return on investment, as this does not consider the property's market valuation. Similarly, dividing NOI by revenue would provide a percentage of operating efficiency rather than an investment return measure, while dividing by property management fees does not relate to the overall value of the investment. Hence, these alternatives miss the key component of market value, which is essential for the cap rate calculation.