Let's say you're an investor looking to buy an apartment building—It's a simple calculation to see if the asking price equates to a solid investment.

Obtain the CAPITALIZATION RATE by dividing the NOI (net operating income) by the ASKING PRICE.

The higher the "cap rate" the better your return on investment.

Example:

In this example, you are looking for a 7-10% cap rate.

The NOI is calculated as follows: $1750 annual rent x 12 months x 3 units = $63,000.

Subtract $4,600 for yearly building expenses (real estate taxes, water, repairs).

NOI = $58,400

If the ASKING PRICE for this three-unit building is $595,000, did you get the 7-10% you were looking for?

Answer: 

CAPITALIZATION RATE = .098 = 9.8%

Yes! The 9.8% cap rate is well within the 7-10% cap rate you were looking for!

Using this diagram/formula one may conversely substitute an unknown value if the other two are known to obtain what the price should be, or necessary rent to make an investment work.