Cap Rates Explained

The capitalization rate — cap rate — is the ratio of a property's net operating income to its value. Quoted as a percentage, it's the first number every investor asks for, and the one most often misread. A cap rate is not a return, not an interest rate, and not a measure of risk on its own. It's a snapshot of one year's income relative to price.

The formula — and what goes into it

Cap Rate = Net Operating Income ÷ Value. The simplicity hides the work. NOI must be normalized: gross income minus operating expenses, with a vacancy allowance and a capital-reserve deduction. A cap rate on an unverified rent roll is a fiction. The value side is straightforward — it's the price — but the income side is where underwriting discipline lives.

“A cap rate quoted without the NOI behind it is a number, not an analysis. Underwrite the income first.”

— Hiren Patoliya

What a cap rate does — and doesn't — tell you

• It tells you the unlevered, one-year income yield at the purchase price.
• It does NOT account for financing — that's cash-on-cash return.
• It does NOT account for appreciation, amortization, or tax benefits — that's IRR.
• It does NOT measure risk directly — a higher cap rate usually signals higher perceived risk, but context matters.
• It varies by asset class, submarket, tenancy credit, and lease structure.

GTA cap rates by asset class — a rough map

Cap rates vary by asset class, submarket, tenancy credit, and lease structure — and they shift as the market moves. A single-tenant, long-lease industrial building in Brampton will price differently than a multi-tenant retail plaza with rolling leases. I track current GTA cap rates by asset class and submarket — ask me for the latest numbers for the property you're underwriting.

Using cap rate in your underwriting

Use the cap rate as a first screen — does the one-year yield meet your threshold? — then layer in financing for cash-on-cash, model the hold for IRR, and stress-test vacancy and rent. The cap rate gets you in the door; the full underwriting decides whether you walk through it. If you want a second set of eyes on a deal's underwriting, send it over.