How do you calculate the capitalization rate (cap rate) in real estate investing?

The capitalization rate, often referred to as the cap rate, is a key metric used in real estate investing to assess the profitability of an income-generating property. To calculate the cap rate, the correct method is to divide the net operating income (NOI) by the property's value.

Net operating income represents the income generated from an investment property after subtracting all operating expenses, excluding mortgage payments and taxes. By dividing the NOI by the property's market value, investors can determine the rate of return on their investment. This is essential for comparing the relative value of different investment properties, as a higher cap rate generally indicates a potentially better return on investment, while a lower cap rate may suggest a lower risk or higher property value.

This method is crucial for investors as it helps them make informed decisions when evaluating various properties based on their income-producing potential. Understanding this calculation allows investors to assess whether a property meets their financial goals and investment criteria.