Understanding Cap Rates & ROI in Commercial Real Estate

Cap rates and ROI metrics are how commercial real estate gets priced, compared, and financed. If you can’t quickly translate a rent roll and expense set into NOI, then convert that into a cap rate, you’re guessing—especially when comparing different asset classes like industrial, retail, office/medical, and multi-unit.

This guide breaks down what cap rates actually measure (and what they don’t), how ROI is calculated in real life when debt is involved, and which metrics investors use to avoid overpaying.

Ready to take the next step? (587)-719-5523 / Get in touch or visit MohitDhillon.com with us today to discuss your commercial real estate goals or schedule a personalized property tour.

Cap Rate Snapshot

The fast way investors compare income properties

Key Highlights

Cap Rate = NOI ÷ Value
Cap rate compares similar assets, not “all deals”
Cap rate is unlevered (it ignores financing)
Cash-on-cash shows your equity yield
IRR shows total return over time

Cap Rate

A cap rate is the relationship between a property’s net operating income and its price/value. It’s mainly used as a quick comparison tool across similar properties in the same market, and it’s often treated as a shorthand for “risk vs. price” (higher cap rates typically reflect higher perceived risk, all else equal).

NOI Basics

NOI is the income left after operating expenses—before debt payments and income taxes. If NOI is wrong, everything downstream is wrong (cap rate, value, financing strength). Clean underwriting means using realistic vacancy/credit loss, verifying recoveries (if applicable), and normalizing expenses so the NOI reflects what a buyer will actually receive.

ROI Metrics

ROI in commercial real estate isn’t one number—it depends on what you’re measuring. Cap rate tells you the property’s unlevered yield. Cash-on-cash return tells you the annual cash return on the actual cash you invested. IRR is used when you want a single annualized return that accounts for the timing of all cash flows over the hold period, including sale proceeds.

Debt Impact

Financing can make a “low cap rate” deal produce strong equity returns—or crush it—depending on interest rate, amortization, and loan terms. This is why investors separate unlevered metrics (cap rate) from levered metrics (cash-on-cash, IRR) and stress test debt payments against realistic NOI.

Risk Signals

Cap rates move because risk moves: tenant strength, lease term remaining, vacancy risk, capital costs, and market interest-rate expectations all influence how buyers price income. The most common trap is treating cap rate like a universal truth, instead of a market signal that must be tied back to lease quality, in-place rents vs. market rents, and asset condition.

Common Errors

The fastest way to misprice a deal is using pro-forma NOI without proof, ignoring upcoming capital expenses, or comparing cap rates across completely different asset types/locations. Cap rate is a starting point—serious buyers model cash flows, confirm rent sustainability, and factor financing reality before calling something a “good return.”

Investor Deep Dive

What cap rates don’t tell you—and how pros close the gap

Cap rates are useful, but they leave out major parts of the investment story: leverage, time value of money, future cash flow changes, and the cost of capital. That’s why sophisticated investors use cap rate as a first filter, then move into a cash flow model that includes real financing terms, tenant rollover risk, and realistic rent/expense growth assumptions.

A practical approach is: validate NOI → compare going-in cap rate to local comparables → run cash-on-cash based on actual equity required → run a hold-period model and compute IRR. This sequence forces the deal to “pass” multiple lenses, instead of relying on one metric that can be distorted by temporary vacancy, underreported expenses, or aggressive income projections.

MOHIT DHILLON

Mohit Dhillon — Calgary Commercial Real Estate Advisor

587-719-5523 mohit.dhillon@century21.ca

I work with investors and owner-operators across Alberta on acquisitions in industrial, retail, office/medical, and multi-unit. My focus is underwriting clarity: validating NOI, interpreting lease risk, and building a deal structure that aligns with financing reality—so buyers don’t overpay and sellers understand what the market will actually support.

FAQ's

What is a cap rate in commercial real estate?
A cap rate is an estimate of return based on a property’s NOI divided by its value/price.

Is a higher cap rate always better?
Not automatically. Higher cap rates often signal higher risk (tenant quality, vacancy, location, or asset condition). You need context.

Why do cap rates ignore my mortgage?
Cap rates are designed to be unlevered so investors can compare properties without mixing in different financing structures.

What’s the difference between cap rate and cash-on-cash return?
Cap rate is based on NOI and value. Cash-on-cash is based on annual cash flow to you compared to the cash you actually invested.

What is IRR and when should I use it?
IRR is an annualized return that accounts for all cash flows over time, including sale proceeds—useful for comparing deals with different hold periods or uneven cash flows.

Can two properties with the same cap rate be very different deals?
Yes. Lease term remaining, tenant covenant, expense recoveries, capex needs, and rent upside/downside can change the true risk dramatically.

What’s the biggest mistake investors make with cap rates?
Using pro-forma NOI without proof and comparing cap rates across different asset classes or markets like they’re directly equivalent.

How do I sanity-check an investment quickly?
Start with verified NOI and a realistic cap rate range from comparable sales, then check cash-on-cash using actual equity required and real debt terms.

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