Valuation and Analysis, 14% of the examination
Capitalization rate
Annual net operating income divided by property value, expressed as a percentage. A cap rate is not total investment return.
The IRV relationship carries the arithmetic: Income divided by Rate gives Value, Income divided by Value gives Rate, and Rate times Value gives Income. Holding NOI constant, a lower cap rate produces a higher indicated value and a higher cap rate produces a lower value. Market cap rates can reflect risk, expected growth, location, property condition, lease quality, and capital-market conditions, so no cap rate by itself proves that one investment is better.
What this is confused with
The exam rarely asks for a definition. It describes a situation and offers two terms that both sound plausible.
Gross rent multiplier
GRM uses gross income and a price, with no deduction for vacancy or expenses.
Cash-on-cash return
Cash-on-cash divides cash flow after debt service by the cash invested, so it depends on financing. Cap rate ignores financing.
See also
Test the distinction
A relevant question from Valuation and Analysis, selected because its facts or explanation use this concept.
A property has an NOI of $84,000 and comparable properties sell at a 7% capitalization rate. What is the indicated value?
Written to DRE's published topic list. Not a real examination question, since reproducing those is a misdemeanor under B&P Code section 123.
Primary sources
Use these authorities when a course summary, forum answer, or older flashcard conflicts with the current California rule.