How is value computed using direct capitalization from NOI?

• A. Value = NOI divided by terminal cap rate (or going-in cap rate)
• B. Value = NOI times cap rate
• C. Value = PGI divided by cap rate
• D. Value = NOI divided by discount rate

Answer: (A)

Direct capitalization uses a single-year stabilized net operating income and an appropriate cap rate to estimate value. The cap rate represents the investor’s required return for the risk of the income stream, so value is the income divided by that rate. Put simply, a given NOI is converted into value by dividing by the cap rate: higher cap rate implies lower value, lower cap rate implies higher value. In this framework, you use NOI (not gross income) and divide by the cap rate to reflect the return demanded by buyers. Using NOI times the cap rate would overstate the price, using gross income neglects expenses, and using a discount rate refers to a multi-period discounted cash flow rather than a single-period capitalization.