How is the capitalization rate of a property calculated?

The capitalization rate, commonly referred to as the "cap rate," is a crucial metric in real estate that helps investors assess the potential return on an investment property. It is calculated by dividing the net operating income (NOI) of the property by its market value or purchase price. This formula provides a percentage that represents the expected annual return on investment, allowing investors to compare different properties and determine their relative profitability.

To put it in context, the net operating income is derived from the property's income after accounting for operating expenses but before financing costs and taxes. By focusing on the income generated by the property relative to its value, the capitalization rate offers insights into the efficiency of the property as an investment and is essential for making informed purchasing decisions.

Other choices do not accurately reflect the process for determining the cap rate. Adding total revenue to operational expenses would not yield a useful financial metric in this context, and subtracting financing costs from net income is unrelated to the cap rate formula, as financing costs are not considered when calculating NOI. Evaluating tenant satisfaction ratings is important for property management but does not play a role in the financial analysis represented by the capitalization rate.