Cap rates and multiples move in which direction relative to each other?

• A. Direct
• B. Inverse
• C. Unrelated
• D. Unclear

Answer: (B)

The key idea here is that cap rate and price multiple are reciprocals of each other in real estate valuation. The cap rate is calculated as NOI divided by value (Cap rate = NOI / Value). The price multiple, often called value per NOI, is value divided by NOI (Value per NOI = Value / NOI). Because one is NOI over value and the other is value over NOI, they are inverses: Cap rate × Price multiple = 1.

So as the price multiple rises (property value for a given NOI goes up), the cap rate falls (return on value falls). Conversely, if the cap rate rises, the price multiple falls. A quick example helps: with NOI of 100 and value 1,000, the cap rate is 10% and the price per NOI is 10. If value increases to 1,500, the cap rate drops to about 6.67% while the price per NOI rises to 15. This shows the inverse relationship.