Capitalization Rate

The capitalization rate — usually shortened to cap rate — is a property's net operating income divided by its value or purchase price, expressed as a percentage. It estimates the unlevered return an income-producing property is expected to generate, before any mortgage financing is considered.

Because it strips out borrowing, the cap rate compares properties on their income alone. It is a staple of investment analysis, appraisals, and the underwriting that private and alternative lenders apply to rental real estate.

How a capitalization rate is calculated

The first step is net operating income (NOI), which is the property's gross rental income minus operating expenses. Typical expenses include property tax, insurance, repairs and maintenance, property management, utilities paid by the landlord, and an allowance for vacancy.

Mortgage payments are not deducted. That is deliberate: the cap rate describes the property, not the borrower's financing. Dividing NOI by the property's value or purchase price gives the cap rate:

Cap rate = Net operating income ÷ Value

Arithmetically, a property whose net operating income equals one-tenth of its price has a cap rate of 10%, while the same income on a property priced twice as high produces 5%.

What the number does — and does not — tell you

• A higher cap rate means more income for each dollar of price, which usually reflects greater perceived risk — a weaker market, an older building, or uncertain rents.
• A lower cap rate means a higher price for the same income, common in desirable markets where buyers accept a smaller return.
• It ignores mortgage costs, so it is not the same as cash flow, which is measured after debt payments.
• It uses net income, so it is more refined than the gross rent multiplier, which relies on gross rent alone.

Why it matters in Canada

For a buyer evaluating a rental property, the cap rate is one of the quickest checks on an asking price, and it lets you compare a duplex with a small apartment building in the same city. Lenders that finance rentals, including B-lenders and private lenders, often weigh it alongside debt service coverage and rental income qualification when sizing a mortgage.

Cap rates are not regulated, and there is no single published national figure. They move with interest rates: when the Bank of Canada policy rate and bond yields rise, cap rates tend to rise and values tend to fall. Cap rates are also subjective, since they depend on comparable sales and on an appraiser's expense assumptions. Confirm current market data from CMHC rental market reports and local sources before relying on any figure.