If cap rate decreases while NOI is constant, what happens to the property value?

If cap rate decreases while NOI is constant, what happens to the property value?

• A. Increases
• B. Decreases
• C. No change
• D. Not determinable

Answer: (A)

In real estate valuation using the income capitalization approach, property value is found by dividing NOI by the cap rate (Value = NOI / cap rate). If NOI stays the same and the cap rate decreases, the denominator becomes smaller, so the value increases. For example, with NOI of 100,000, dropping the cap rate from 7% to 6% raises value from about 1.43 million to about 1.67 million. The cap rate reflects the market’s required return; when that requirement falls, the present value of the income stream rises, leading to a higher property price.

In real estate valuation using the income capitalization approach, property value is found by dividing NOI by the cap rate (Value = NOI / cap rate). If NOI stays the same and the cap rate decreases, the denominator becomes smaller, so the value increases. For example, with NOI of 100,000, dropping the cap rate from 7% to 6% raises value from about 1.43 million to about 1.67 million. The cap rate reflects the market’s required return; when that requirement falls, the present value of the income stream rises, leading to a higher property price.