This discounting factor is used to place a value on the present stream. The selection of the Cap Rate reflects the appraiser’s best judgment as to the quality, quantity and durability of the income stream to be generated by the property in question.
The lower the rate, the more money the seller receives and the more money a buyer will pay. Market Values are most often determined by dividing the Net Operating Income (NOI) by the Cap Rate.
- For a property with an NOI of $100,000 and a CAP Rate of 7.5%, divide $100,000 by 7.5%.
- This indicates a Market Value of $1,333,333.
- NOI ÷ Cap Rate = Market Value
Investors also use Cap Rates to adjust the risk factor. They are also strongly affected by interest rates. The Cap Rate is the yield you would receive if you paid all cash for the property. When interest rates are above 7.5%, you will be paying a higher rate than the “yield”. The property may still cash flow nicely even with this inverted situation, especially if the property is not over leveraged.