Nationwide Mortgage Licensing System (NMLS) Practice Exam

What factor increases the cap rate in real estate?

1. Lower purchase price

2. Increase purchase price

3. Decrease cash flow

4. Increase interest rate

The correct answer is: Increase purchase price

The cap rate, or capitalization rate, is a measure used in real estate to indicate the expected rate of return on an investment property, calculated by dividing the property's net operating income (NOI) by its current market value or purchase price. An increase in the cap rate typically signifies that a property is providing a higher return relative to its price. When the purchase price of a property decreases, the cap rate increases, as the same level of cash flow is being divided by a smaller denominator (the lower purchase price). Conversely, an increase in the purchase price results in a lower cap rate if the net operating income remains unchanged, as the higher price reduces the ratio of income to value. The relationship between cap rate and interest rates is also significant. When interest rates increase, borrowing costs rise, which can impact property values and cap rates. Higher interest rates might lead to a decrease in property demand, thus increasing the cap rate in the market environment overall. A decrease in cash flow would also lead to a higher cap rate because, with the same price, a lower cash flow means that the property is less financially stable, thus increasing perceived risk. Consequently, while a higher purchase price does not increase the cap rate—in fact, it would decrease the