What is a cap rate (capitalization rate)?
A capitalization rate is the annual net operating income of a property divided by its purchase price, expressed as a percentage, used to evaluate the expected return on an income-generating property.
The capitalization rate, or cap rate, is a metric that expresses the relationship between a property's annual net operating income and its market value. It is calculated by dividing net operating income (rental income and other revenue minus operating expenses) by the purchase price or current market value of the property, then multiplying by 100 to express it as a percentage. A property generating $100,000 in net operating income with a value of $1,000,000 would have a cap rate of 10 percent.
Real estate professionals and investors use cap rates to compare the income-producing potential of different commercial properties on a standardized basis. A higher cap rate generally indicates a lower purchase price relative to income, which may suggest a better return opportunity, while a lower cap rate suggests the opposite. Cap rates vary by property type, location, condition, and market conditions.
For commercial real estate agents in London, Ontario, cap rates serve as a fundamental tool for valuing office buildings, retail spaces, industrial properties, and multi-unit residential investments. Investors rely on cap rate analysis alongside other metrics to make acquisition decisions and assess portfolio performance. Understanding cap rates helps buyers, sellers, and agents communicate clearly about property value and expected yield.