What Is A Cap Rate?

The cap rate is quick and effective tool for an investor to evaluate a property. The methodology for calculating the cap rate is as follows: The cap rate is determined by dividing the net operating income of a property [Revenues-Operating Costs] by the purchase price. The formula does not include mortgage payments, as every investor handles debt differently.

The assumption is that a buyer will acquire property without debt, making it easier for an investor to compare apples to apples.

The cap rate does not consider factors like location or the condition of a property. Most cities work off their cap rate, which becomes a standard baseline to evaluate all properties within an area or geographic region.

The standard cap rate in Toronto ranges from 3-4% in the residential sector. If an investor can achieve more than 4%, they are doing very well, indicating that the property potentially outperforms similar-type assets.

One significant consideration for any investor is how to add value to a property to increase its potential cap rate or property value over time and at what cost.

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