Capitalization Rate

Cap Rate

A property's annual net operating income divided by its value or price, used to compare income properties without the effect of financing.

The capitalization rate, or cap rate, measures an income property's return from its operations. It is the annual net operating income (NOI) divided by the property's current market value or price, shown as a percentage. A building with $40,000 of NOI and an $800,000 price has a cap rate of 5%.

Net operating income is gross rental revenue minus the typical costs of operating and maintaining the property. These include property tax, insurance, repairs and management, and often an allowance for vacancy and future replacements. Mortgage payments and depreciation are not deducted. That means the cap rate ignores how the purchase is financed, which makes it useful for comparing properties.

Appraisers and assessors also use it in reverse. Under the income approach, value is estimated by dividing NOI by a cap rate taken from comparable sales. A lower cap rate means a higher price for the same income. Higher cap rates generally signal higher risk, and lower rates signal lower risk.

The cap rate has limits. It looks at one year of income and does not capture appreciation, financing costs or your cash return after the mortgage. Definitions also vary, and some listings quote rates based on projected rents or light expense estimates. A cap rate is only as reliable as the NOI behind it.

Rebuilding the figure yourself, with realistic vacancy, repairs, management and current property taxes, gives a fairer comparison. It works best alongside other measures, such as cash flow after debt service and the gross rent multiplier. No single cap rate is right for every investor, since the acceptable level depends on risk tolerance and local market conditions.

General information only, not legal, tax, or financial advice. Rules change and vary by province; confirm the current details with the relevant authority before you rely on them.