Insights · Buy
Cap Rates Explained. Commercial Property Ontario.
Cap rates are the most widely used metric in commercial real estate investment — and the most widely misunderstood. This is a plain-language explanation of what cap rates mean, how they are calculated, and what they tell you about a property.
What a Cap Rate Actually Is
Net Income Divided
by Purchase Price.
Cap rate (capitalisation rate) = Net Operating Income ÷ Purchase Price. A property generating $200,000 in NOI that sells for $4,000,000 has traded at a 5% cap rate. That's the entire formula. The complexity is in what goes into NOI and how buyers and sellers disagree on its calculation.
NOI = Gross rent minus operating expenses (property tax, insurance, maintenance, management), before debt service. It does not include mortgage payments — cap rates are a pre-financing metric. Two buyers with different financing structures can both correctly quote the same cap rate on the same property.
What Drives Cap Rate Compression
Risk, Duration,
and Alternative Returns.
Cap rates compress (get lower) when: interest rates fall and bond yields drop; tenant covenants strengthen; lease terms lengthen; or market demand for a property type increases relative to supply. Ontario industrial cap rates compressed from 6–7% in 2015 to 3.5–4.5% by 2022 as industrial demand surged.
Cap rates expand (get higher) when: financing costs rise; market vacancy increases; or tenant risk increases. The 2023–2024 rate environment pushed industrial cap rates back toward 5–5.5% in most GTA submarkets — still historically compressed, but meaningfully wider than peak.
How to Use Cap Rates Intelligently
Compare Within
Asset Class and Submarket.
Cap rates are only meaningful in context. A 5% cap on a Mississauga industrial asset and a 5% cap on a downtown office building are not equivalent risks. Asset class, submarket, tenant credit, lease term and building quality all affect what cap rate a specific property deserves.
Lucero underwrites acquisitions using current comparable transaction data — not asking price cap rates from listings. The spread between asking and transaction cap rates on any given asset often reveals how a vendor is pricing expectation rather than market reality.