Net Operating Income Definition and Calculation

Capitalization rates are used in the valuation of commercial real estate. Using the income from a property, known as Net Operating Income or NOI, you can divide this income by the capitalization rate to determine the value of the asset. Using this method you are basically determining what sort of cash return the property is generating as an unleveraged asset. The NOI is always calculated before debt service, as each potential owner of the same asset may or may not use debt. Cap Rates will differ from market to market and between different asset types. Usually higher risk properties demand higher cap rates, or larger returns on the money invested in that particular property.

Capitalization Rate (Cap Rate) Calculation

Net Operating Income
/ Purchase Price
* 100 (to give a percentage)
= Capitalization Rate