Cap Rate vs Cash-on-Cash Return
Cap rate divides a property's net operating income by its price or value, so it describes the property and ignores how it is financed. Cash-on-cash return divides your yearly pre-tax cash flow, after the mortgage, by the cash you actually put in, so it describes your deal. The same building has one cap rate but a different cash-on-cash return for every financing choice.
Cap rate vs Cash-on-cash side by side
| Cap rate | Cash-on-cash | |
|---|---|---|
| Formula | Net operating income ÷ price (or value) | Annual pre-tax cash flow ÷ total cash invested |
| Includes the mortgage? | No - measured before debt service | Yes - cash flow is after debt service |
| Describes | The property and its price | Your return on your own cash |
| Changes with the down payment? | No | Yes - leverage moves it up or down |
| Typical use | Comparing properties and market pricing | Comparing how you finance and where you put your cash |
| Can be negative? | Only if NOI is negative | Yes, whenever debt service exceeds NOI |
Full definitions: Cap Rate, Cash-on-Cash Return.
When to use each one
Use cap rate to screen and price properties. Because it ignores financing, it lets you compare a duplex bought with cash and a fourplex bought with a loan on equal terms, and it is how appraisers and brokers express what the market pays for a stream of income.
Use cash-on-cash return to decide whether your particular deal - with your down payment, rate and closing costs - pays you enough on the cash you tie up. It is the number to compare with other places that cash could go.
How leverage separates them
When the cost of borrowing is below the property's cap rate, a loan lifts cash-on-cash return above the cap rate (positive leverage). When the mortgage constant is higher than the cap rate, borrowing drags cash-on-cash below it (negative leverage). That is why rising rates can make the same property, at the same price, a poor leveraged investment.
Cash-on-cash return and leverage
Cash-on-cash return is the yearly cash flow divided by the cash you put in. The down payment changes both sides, so the same property can return very different rates.
- Cash-on-cash return
- 3.48%
- First-year, before tax
- Cash invested
- $88,000
- Down payment and closing costs
- Yearly cash flow
- $3,064
Show the numbers as a table
| Down payment | Cash invested | Cash flow / year | Cash-on-cash | Cap rate |
|---|---|---|---|---|
| 20% | $72,000 | $1,819 | 2.53% | 7.33% |
| 25% | $88,000 | $3,064 | 3.48% | 7.33% |
| 35% | $120,000 | $5,555 | 4.63% | 7.33% |
| 50% | $168,000 | $9,291 | 5.53% | 7.33% |
| 100% | $328,000 | $21,744 | 6.63% | 7.33% |
Formula
Cash-on-cash = Annual pre-tax cash flow ÷ Total cash invested × 100Assumptions
- 30-year fixed loan, no points; one unit with no other income, HOA or utilities.
- Vacancy is taken off gross rent; management, maintenance and the capital-expenditure reserve are a share of collected rent.
- The capital-expenditure reserve sits below NOI: it is cash set aside, not an operating expense.
- Income taxes, depreciation and appreciation are left out.
Worked examples
Cap rate on a $400,000 rental
Illustrative example - round numbers, not current market data. Calculated with Reaixo's calculator engines.
Assumptions
- Purchase price
- $400,000
- Market rent
- $3,000 a month
- Vacancy and credit loss
- 5%
- Operating expenses (taxes, insurance, repairs, management)
- $10,200 a year
| Step | Calculation | Result |
|---|---|---|
| 1. Gross potential rent | $3,000 × 12 | $36,000 |
| 2. Less vacancy | $36,000 × 5% | $1,800 |
| 3. Effective gross income | $36,000 − $1,800 | $34,200 |
| 4. Net operating income | $34,200 − $10,200 | $24,000 |
| 5. Cap rate | $24,000 ÷ $400,000 × 100 | 6.00% |
Cap rate: 6.00%. Before any mortgage, the property earns 6.00% of its price a year from operations. A buyer who paid $450,000 for the same income would earn only 5.33%.
What this calculation leaves out
- Mortgage payments are not in NOI, so cap rate says nothing about cash flow after financing.
- Capital expenditures such as a new roof are usually shown below NOI; a property with a large backlog can look better than it is.
- The result is only as good as the rent, vacancy and expense estimates. Use actual operating statements when you can.
Cash-on-cash return with a 25% down payment
Illustrative example - round numbers, not current market data. Calculated with Reaixo's calculator engines.
Assumptions
- Purchase price
- $300,000
- Down payment
- 25% ($75,000)
- Closing costs and initial repairs
- $9,000 and $6,000
- Loan
- $225,000 at 7.00%, 30 years
- Net operating income
- $25,200 a year
| Step | Calculation | Result |
|---|---|---|
| 1. Total cash invested | $75,000 + $9,000 + $6,000 | $90,000 |
| 2. Monthly principal and interest | $225,000 at 7.00% over 360 months | $1,496.93 |
| 3. Annual debt service | $1,496.93 × 12 | $17,963 |
| 4. Annual pre-tax cash flow | $25,200 − $17,963 | $7,237 |
| 5. Cash-on-cash return | $7,237 ÷ $90,000 × 100 | 8.04% |
Cash-on-cash return: 8.04%. Each year the investor receives about 8.0% of the cash they put in, before income taxes. The same property's cap rate is 8.40%, which ignores the loan entirely.
What this calculation leaves out
- Pre-tax and first-year only: it ignores appreciation, principal paydown and tax effects.
- Leave reserves out of "cash invested" only if you are sure you will not need them; many investors include them.
- A higher rate or a vacancy month can turn a thin cash flow negative - test the downside.
Common misconceptions
- A higher cap rate is always better. It often signals more risk or a weaker location; see "Is a higher cap rate always better?".
- Cash-on-cash return is total return. It ignores appreciation, principal paydown and tax effects.
- Cap rate uses rent. It uses net operating income - rent after vacancy and operating expenses, before the mortgage.
- You can compare a cap rate with a cash-on-cash return. They answer different questions with different denominators.
Frequently asked questions
Which is more important, cap rate or cash-on-cash return?
Neither on its own. Cap rate tells you whether the price is fair for the income; cash-on-cash tells you whether your financed deal pays enough on your cash. Investors check both.
Why is my cash-on-cash return lower than the cap rate?
Because your borrowing costs more than the property yields. When the loan's annual payment as a share of the loan is higher than the cap rate, leverage reduces your return.
Does cap rate include the mortgage payment?
No. Cap rate is calculated from net operating income, which is before any debt service.
Calculators and guides
Recommended next step
See NOI, cap rate, cash flow and cash-on-cash return together for one set of assumptions.
Run both numbers on a real property →Sources and review
No regulator defines these terms; the page follows common industry practice and labels rules of thumb as such.
Where this applies: Not regulated. Investment ratios are industry conventions; lenders and analysts may define the inputs differently, so always check how a figure was calculated.
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Worked examples use illustrative round numbers, not current market data. Rates, limits and program rules change - confirm current figures with your lender or a qualified professional.
General educational information, not financial, legal, tax or real estate advice. Rules vary by loan program, transaction and location - verify important decisions with qualified professionals.