Guides for Canadian real estate investors
What Is Cap Rate? How to Calculate and Use It in Canada
Cap rate is one of the most commonly used metrics in real estate investing. It tells you how much income a property generates relative to its price, independent of how you financed the purchase. Here is how to calculate it, what the numbers mean in Canadian markets, and when to use other metrics instead.
What cap rate means
Cap rate, short for capitalization rate, is the ratio of a property's net operating income to its purchase price, expressed as a percentage. It answers the question: if you paid cash for this property, how much of your investment would you earn back each year through rental income?
The reason cap rate strips out the mortgage is intentional. By removing financing from the calculation, cap rate lets you compare two properties on equal terms, regardless of how either one was purchased. A property with a large mortgage and one purchased outright have the same cap rate if everything else is equal. That makes it a useful benchmark for evaluating the income quality of a property itself rather than the details of your financing.
Cap rate is most useful for comparing similar properties in the same market. A 5% cap rate means something very different in Toronto than it does in Moncton, and something very different for an apartment building than for a single-family home. Context matters as much as the number.
How to calculate cap rate
The formula has two parts. First, calculate net operating income. Then divide it by the purchase price.
Cap rate formula
Net Operating Income
Purchase Price
Multiply the result by 100 to express it as a percentage.
Net operating income = annual rent minus annual operating expenses, not including mortgage payments.
Operating expenses include property taxes, insurance premiums and property management fees. They do not include mortgage principal or interest, capital improvements or depreciation. The deliberate exclusion of the mortgage is what makes cap rate a financing-independent metric.
Worked example
Note that vacancy is not included in this example. A more conservative analysis would reduce the gross rent by an assumed vacancy rate, typically 3 to 5% for well-located residential properties in Canada. Including vacancy gives you a more realistic net operating income figure.
What counts as a good cap rate in Canada
There is no single number that defines a good cap rate in Canada. The right cap rate depends heavily on the market you are buying in, the property type and what you expect from the investment. As a general framework, Canadian markets fall into three tiers.
High-cost markets
3% to 5%
Toronto, Vancouver, Victoria. Investors accept lower income yields because of strong long-term appreciation potential.
Mid-size markets
4% to 7%
Calgary, Edmonton, Ottawa, Winnipeg. Better income yields with meaningful appreciation in stronger cycles.
Smaller markets
6% to 9%+
Saskatoon, Regina, Moncton, smaller cities. Higher income yields, lower appreciation expectations.
These ranges are generalizations. Specific neighbourhoods, property conditions and economic cycles all affect where a given property lands. The most reliable benchmark is what similar properties in the same area are trading at, which is why local market knowledge matters as much as the formula.
A cap rate that is significantly higher than comparable properties in the same area is worth scrutinizing. It often signals something that is already priced into the purchase price, such as deferred maintenance, a below-market lease that will expire, a problem tenant or an undesirable location characteristic.
Cap rate vs cash-on-cash return
These two metrics are often confused. They measure different things and both are useful. Cap rate tells you about the property. Cash-on-cash return tells you about your investment in the property.
| Cap rate | Cash-on-cash return | |
|---|---|---|
| What it measures | Income the property generates relative to its price | Cash flow you receive relative to the cash you invested |
| Includes mortgage? | No. Financing is excluded entirely | Yes. Mortgage payments reduce your cash flow |
| Best used for | Comparing properties to each other and to market benchmarks | Evaluating your actual return on the money you put in |
| Changes if you refinance? | No. Cap rate is about the property, not your loan | Yes. A lower rate or different loan structure changes your cash flow |
| Typical use | Initial screening and market comparison | Final decision and ongoing performance tracking |
What cap rate does not tell you
Cap rate is a useful starting point, not a complete picture. Relying on it alone can lead to poor decisions. Here is what it leaves out.
It ignores appreciation
A property with a 3% cap rate in a market that appreciates 6% per year may outperform a property with a 7% cap rate in a flat market. Cap rate only measures current income, not the total return on your investment over time.
It ignores vacancy
Cap rate is typically calculated on gross rent assuming full occupancy. If you factor in a realistic vacancy rate, the net operating income, and therefore the cap rate, will be lower. Always ask whether a cap rate figure you are given accounts for vacancy or not.
It ignores your financing
A property with a 5% cap rate that you finance at 6% is losing money from the first day. Cap rate tells you nothing about whether the property cash flows positively given your specific mortgage. For that, you need cash-on-cash return and monthly cash flow analysis.
It ignores capital expenditures
A new roof, replaced furnace or updated electrical panel are not included in the operating expenses used to calculate NOI. A property with a high cap rate that also needs $40,000 in near-term capital work may be less attractive than the number suggests.
It can be manipulated in listings
When a seller or agent presents a cap rate, ask exactly how it was calculated. Expenses may be understated, occupancy may be assumed at 100%, or management costs may be excluded because the current owner self-manages. Always recalculate using your own assumptions.
Calculate the cap rate on any Canadian property
Our free calculator shows cap rate, monthly cash flow and cash-on-cash return together, so you get the full picture before making an offer.
Open the calculatorThis guide is for general informational and educational purposes only and does not constitute financial or investment advice. Cap rate benchmarks vary by market, property type and economic conditions. Always conduct your own due diligence and consult a qualified financial advisor before making any investment decisions.