How is the capitalization rate affected as property value decreases?

When property value decreases, the capitalization rate, often referred to as the cap rate, tends to increase. The cap rate is calculated by dividing the net operating income (NOI) of a property by its current market value.

As the property value drops while the NOI remains relatively stable, the calculation results in a higher cap rate. This happens because the same income is being generated by a property that is now valued lower, leading to a higher ratio. An increasing cap rate can indicate higher perceived risk or a declining market, where investors may demand a higher return relative to the purchase price.

Understanding this relationship is crucial for investors and real estate professionals, as it impacts property valuation, investment decision-making, and market analysis.