Cap Rate Calculation Guide for Investment Decisions

How to calculate, interpret, and use capitalization rates to make smarter investment property decisions.

Book A Strategy Call Apply Online

Strategy Call

Discuss your homeownership or investment goals

Custom Solution

We find the right mortgage for your situation

Fast Approval

Get pre-approved in 24-48 hours

Cap Rate Calculation Guide for Investment Decisions

Table of Contents

Get Instant Access to Our Exclusive Weekly Investor Insight

Sent right to your inbox.

You are comparing two investment properties. One is listed at $600,000 and generates $42,000 in net operating income. The other is listed at $450,000 and generates $29,250 in net operating income. Which one is the better deal?

You cannot answer that question by looking at price or income alone. You need a way to normalize the comparison—a single number that tells you what each property earns relative to what it costs. That number is the capitalization rate, and understanding how to calculate and use it is fundamental to making smart investment decisions.

Book Your Strategy Call

The Cap Rate Formula

Cap Rate = Net Operating Income / Property Value x 100

That is the entire formula. Two inputs, one output. But as with most things in real estate, the simplicity is deceptive. The accuracy of your cap rate depends entirely on getting those two inputs right.

For the two properties above:

Property A: $42,000 / $600,000 x 100 = 7.0% cap rate
Property B: $29,250 / $450,000 x 100 = 6.5% cap rate

Property A has a higher cap rate, which means it generates more income per dollar of value. All else being equal, it is the better income-producing deal. But “all else being equal” is doing a lot of heavy lifting in that sentence—and we will get to why shortly.

Calculating Net Operating Income Correctly

NOI is the most important number in commercial real estate, and getting it wrong is the most common mistake investors make. Here is how to calculate it properly.

Start with Gross Potential Income. This is the total rent you would collect if every unit were occupied and every tenant paid in full for the entire year. If you have a 6-unit building with each unit renting at $1,400 per month, your gross potential income is $100,800 per year.

Include all income sources: residential rent, parking fees, laundry revenue, storage unit rentals, and any other income the property generates.

Subtract Vacancy and Credit Losses. No building runs at 100% occupancy with 100% collection. Apply a realistic vacancy rate—typically 3-5% in strong markets, 5-10% in weaker ones. If your gross potential income is $100,800 and you estimate 5% vacancy, deduct $5,040.

Subtract Operating Expenses. This is where most investors make errors. Operating expenses include:

Property taxes
Insurance
Maintenance and repairs
Property management fees (even if you self-manage, include this at 8-10% for an accurate analysis)
Utilities paid by the owner (water, sewer, common area electricity, heat if included)
Landscaping and snow removal
Pest control
Legal and accounting fees
Advertising and leasing costs
Reserves for replacement (typically 5-10% of gross income for capital expenditures)

What operating expenses do NOT include: Mortgage payments. This is critical. NOI is calculated before debt service. The cap rate tells you what the property earns independent of how it is financed. This is precisely why cap rate is useful for comparing properties—it strips out the financing variable.

Also exclude income taxes, depreciation, and any one-time capital expenditures (like a roof replacement). NOI reflects the ongoing operational performance of the property.

The NOI Calculation:

Line Item	Amount
Gross Potential Income	$100,800
Less Vacancy (5%)	-$5,040
Effective Gross Income	$95,760
Less Operating Expenses (40%)	-$40,320
Net Operating Income	$55,440

With this NOI and a property value of $800,000, your cap rate is 6.93%.

Now that you know how to calculate cap rate and set your minimum target, the next step is running the numbers with actual financing—book a free strategy call with LendCity and we’ll show you whether the debt service actually supports the deal or if you need to negotiate a better price.

What Cap Rates Tell You

A cap rate is essentially the return you would earn on a property if you bought it with all cash and no financing. It answers the question: “What percentage of my purchase price comes back to me each year as operating income?”

Higher cap rate = higher income relative to price. A 9% cap rate means the property generates 9 cents of NOI for every dollar of value. A 5% cap rate means 5 cents per dollar. The higher-cap-rate property produces more income per dollar invested.

Cap rate reflects risk perception. Markets and property types with lower perceived risk trade at lower cap rates (higher prices relative to income). Prime urban locations, new construction, and buildings with long-term tenants typically have lower cap rates because investors are willing to pay more for stability.

Higher cap rates often signal higher risk: less desirable locations, older buildings, higher vacancy potential, or markets with weaker fundamentals. The higher return compensates for greater uncertainty.

Cap Rate Range	Risk Profile
3-5%	Premium properties, lower risk, expensive markets
5-7%	Core investments, moderate risk
7-9%	Value-add opportunities, higher risk
9%+	Distressed or challenged, highest risk

Cap rate is a snapshot, not a forecast. It tells you what the property earns today relative to its price today. It says nothing about future appreciation, rent growth, or expense changes. A 4% cap rate property in a high-growth market might outperform an 8% cap rate property in a declining market over a 10-year hold—but the cap rate alone will not tell you that.

How Cap Rates Vary by Market and Property Type

Cap rates are not uniform. They shift based on geography, property type, and market conditions.

By market (Canadian examples):

Major urban centres (Toronto, Vancouver): Typically 3.5-5.5%
Mid-size cities (Ottawa, Calgary, Edmonton): Typically 5-7%
Smaller cities and towns: Typically 6-9%

By property type:

New, well-located apartment buildings: Lower cap rates (4-6%)
Older apartment buildings needing work: Higher cap rates (6-9%)
Mixed-use (retail/residential): Varies widely (5-8%)

By market cycle:

In hot markets with lots of buyer competition, cap rates compress (prices go up faster than income)
In softer markets, cap rates expand (prices fall or stagnate while income holds)

These ranges are generalizations. Actual cap rates depend on the specific property, neighbourhood, tenant quality, building condition, and dozens of other factors. The point is that you cannot judge a cap rate in isolation—you need to compare it to similar properties in the same market.

Here’s what I’ve seen trip up investors: they find a property with a solid 7% cap rate, but when the mortgage payments come due, the DSCR falls below 1.1 and lenders won’t touch it—schedule a free strategy session with us and we’ll help you structure the financing so your cap rate actually translates to cash flow that works.

Using Cap Rates to Compare Properties

This is where cap rate earns its keep. When you are evaluating multiple properties, cap rate gives you an apples-to-apples comparison regardless of price differences.

Consider three properties you are evaluating:

Property	Price	NOI	Cap Rate
4-plex in suburban Ottawa	$650,000	$39,000	6.0%
8-unit in Hamilton	$1,100,000	$77,000	7.0%
12-unit in Moncton	$850,000	$68,000	8.0%

The Moncton building has the highest cap rate—the most income per dollar. But does that make it the best investment? Not necessarily. You need to ask why the cap rate is higher. Is the market weaker? Is the building older? Are the tenants less stable? Is there deferred maintenance?

Cap rate tells you what the numbers are. You need to do the work to understand why.

When comparing properties in the same market of similar quality, the higher cap rate deal is generally better. When comparing across different markets or property types, the cap rate differences reflect risk and growth differences that you need to evaluate independently.

For financing these different property types, your approach will differ. A 4-plex typically falls under residential mortgage financing rules, while 5+ unit buildings qualify for multifamily mortgage financing with potentially better terms through programs like CMHC MLI Select.

Book Your Strategy Call

When Cap Rate Misleads You

Cap rate is useful, but it has blind spots. Here are the situations where relying on cap rate alone will lead you astray.

It ignores financing. Two investors buy the same property. One pays all cash. The other puts 20% down and finances the rest. They experience completely different returns on their invested capital, but the cap rate is identical. If you are using leverage (and most investors are), cash-on-cash return is a more relevant measure of what your money actually earns.

It ignores deferred maintenance. A building might show strong NOI today, but if the roof needs replacement in two years, the boiler is on its last legs, and the parking lot is crumbling, the real cost of ownership is much higher than the operating expenses suggest. A “high cap rate” property with $200,000 in deferred maintenance is not the bargain it appears.

It ignores appreciation potential. A 4% cap rate property in a rapidly growing market might deliver a 15% total return when appreciation is factored in. An 8% cap rate property in a stagnant market might deliver exactly 8%. Cap rate measures current income, not total investment return.

It ignores rent growth. If a building has below-market rents, the current cap rate understates the property’s true earning potential. Savvy investors look for this—they buy at today’s cap rate knowing they can increase income through rent adjustments, value-add renovations, or better management.

It ignores tenant quality. A building full of month-to-month tenants paying above-market rent has a different risk profile than one with long-term tenants on leases at market rates—even if the current NOI and cap rate are identical.

Cap Rate vs Cash-on-Cash Return

These two metrics answer different questions, and you need both.

Cap rate asks: “What does the property earn relative to its value, ignoring financing?”

Cash-on-cash asks: “What does my actual cash investment earn this year, including financing?”

Here is a practical example:

A property sells for $800,000 with $55,000 NOI (6.9% cap rate). You buy it with 25% down ($200,000) plus $20,000 closing costs. Your mortgage payment is $38,000 per year.

Cap rate: $55,000 / $800,000 = 6.9%
Cash flow: $55,000 - $38,000 = $17,000
Cash-on-cash: $17,000 / $220,000 = 7.7%

In this case, leverage improved your return because the cap rate (6.9%) exceeds the cost of the debt. Your mortgage financing costs are lower than what the property earns, so borrowing amplifies your return.

If the mortgage rate were higher and payments were $50,000 per year, your cash flow would drop to $5,000 and your cash-on-cash to 2.3%—even though the cap rate is still 6.9%. This is why cap rate alone is not enough.

Other Metrics to Consider Alongside Cap Rate

While cap rate and cash-on-cash return are foundational, two other metrics provide additional perspective on investment performance.

Internal Rate of Return (IRR) accounts for all cash flows over your entire holding period, including the eventual sale. Unlike cap rate (which is a snapshot) or cash-on-cash (which measures a single year), IRR gives you a comprehensive view of total investment return across multiple years. This is particularly useful when comparing properties with different growth trajectories or exit timelines.

Gross Rent Multiplier (GRM) is calculated by dividing property price by annual gross rent. It is a quick screening tool that requires no detailed expense analysis—useful for initial filtering before you dig into full cap rate and cash-on-cash calculations. However, GRM ignores operating expenses entirely, so it should never replace proper NOI-based analysis.

Using Cap Rate to Set Offer Prices

This is one of the most practical applications of cap rate. If you know what cap rate you need to make a deal work, you can calculate the maximum price you should pay.

The formula flipped: Property Value = NOI / Target Cap Rate

If a property generates $60,000 in NOI and you need a 7% cap rate to meet your return targets:

$60,000 / 0.07 = $857,143

That is the most you should pay. If the seller wants $950,000, you know the deal does not work at your target return—unless you can increase income or reduce expenses after purchase.

This approach is especially useful at auction or when evaluating off-market deals where there is no comparable sale to anchor the price. Let the income tell you what the property is worth to you.

You can also use this approach alongside the CMHC MLI Max Loan Calculator for multifamily buildings. Calculate your target price based on cap rate, then check whether the financing works at that price. If the DSCR requirement limits your borrowing below what you need, either the price is too high or the income is too low.

Use our DSCR Loan Calculator — Canadian Edition to see whether a property’s income supports the financing at your target purchase price.

Building Cap Rate Into Your Deal Screening Process

Here is a practical workflow:

Know your market cap rates. Before you look at any deal, understand what similar properties are trading at in your target market. Talk to brokers, review recent sales, and check investor resources and market data.
Set your minimum cap rate. Based on your return requirements and financing costs, determine the lowest cap rate you will accept. This becomes your first filter.
Verify the NOI. Never trust the seller’s NOI without verification. Request two to three years of financial statements, tax returns, utility bills, and property tax assessments. Recalculate NOI using your own expense assumptions.
Adjust for reality. If you find below-market rents, the going-in cap rate understates the potential. If you find deferred maintenance, the going-in cap rate overstates the real return. Adjust your analysis accordingly.
Run both cap rate and cash-on-cash. Cap rate tells you whether the property is priced fairly relative to income. Cash-on-cash tells you whether the deal actually works with your financing. You need both to make a good decision.

Frequently Asked Questions

Why do cap rates vary between markets?

Cap rates reflect supply and demand dynamics, perceived risk, growth expectations, and local economic conditions. Strong markets with high investor demand, limited supply, and robust economic fundamentals typically have lower cap rates—investors accept lower income yields in exchange for stability and appreciation potential. Conversely, markets with weaker demand, higher vacancy, or economic uncertainty trade at higher cap rates to compensate for the added risk.

Can I use cap rates for single-family rentals?

The cap rate concept applies to single-family rentals, but the metric is more commonly used for commercial and multifamily properties where income stability is higher and comparables are more standardized. Single-family investors often rely more on price-to-rent ratios, cash-on-cash return, and appreciation potential. Cap rates work better when comparing income-producing assets at scale.

What is a good cap rate?

It depends on your market and property type. In major Canadian cities, 5-6% is considered solid for apartment buildings. In smaller markets, 7-9% is achievable. The "right" cap rate is one that, combined with your financing terms, produces a cash-on-cash return that meets your investment criteria.

Can cap rate be negative?

Technically, yes—if operating expenses exceed income, NOI is negative, and so is the cap rate. This typically happens with vacant or severely underperforming properties. A negative cap rate tells you the property costs money to operate, not that it earns money.

Should I use purchase price or appraised value for cap rate?

Use purchase price when evaluating a specific deal (what return are you getting at the price you are paying). Use appraised value or market value when evaluating your current portfolio (what return is your equity generating at today's values).

How does cap rate relate to DSCR?

Both use NOI, but they measure different things. Cap rate compares NOI to property value. DSCR compares NOI to debt service (mortgage payments). A property can have a strong cap rate but a weak DSCR if it is heavily leveraged. When applying for multifamily mortgage financing through CMHC, the minimum DSCR is 1.1—meaning NOI must be at least 10% more than your mortgage payments.

Do cap rates include property management fees?

They should. NOI should reflect all operating expenses, including property management. If the seller's financial statements do not include management fees because they self-manage, add 8-10% of gross income to expenses before calculating cap rate. This gives you a realistic, transferable number.

Is a lower or higher cap rate better?

As a buyer, a higher cap rate means more income per dollar spent—generally better. As a seller, a lower cap rate means your property commands a premium price. The market determines cap rates through supply and demand. Your job as an investor is to buy at cap rates that make financial sense for your goals.

How often should I recalculate cap rates?

Recalculate annually for your existing portfolio using current NOI and current property values. This tells you whether your equity is working hard enough. If a property's cap rate has compressed significantly (value went up more than income), it might be time to sell or refinance and redeploy that equity through residential mortgage refinancing.

Turn Your Numbers Into Action

Cap rate is one of the most useful tools in your analytical toolkit—but only if you calculate it correctly and understand its limitations. It tells you what a property earns today relative to its price. It does not tell you about financing, future growth, or hidden costs.

The best investors use cap rate as a starting point, not an ending point. They combine it with cash-on-cash return, DSCR analysis, and thorough due diligence to make decisions based on the full picture.

If you have a deal you are evaluating and want to pressure-test your numbers with someone who analyzes mortgage financing for Canadian investors every day, that is exactly what a strategy call is for. Bring your cap rate, your cash-on-cash calculation, and your questions. We will tell you whether the deal works and how to structure it.

Book Your Strategy Call

Disclaimer: LendCity Mortgages is a licensed mortgage brokerage, and our team includes experienced real estate investors. While we are qualified to provide mortgage-related guidance, the broader financial, tax, and legal information in this article is provided for educational purposes only and does not constitute financial planning, tax, or legal advice. For matters outside mortgage financing, we recommend consulting a Chartered Professional Accountant (CPA), licensed financial planner, or qualified legal advisor.

Written by

LendCity

Published

February 14, 2026

Reading Time

13 min read

Share this article