Cap Rate vs. Cash-on-Cash Return: Formulas & Example

Cap rate measures a property's operating income relative to its price. Cash-on-cash return measures annual cash flow relative to your cash invested. The first excludes financing; the second depends on it. Use both when you compare rentals.

How to calculate cap rate

Begin with annual rent after vacancy and collection losses. Subtract operating costs such as taxes, insurance, management, routine maintenance and owner-paid utilities to estimate NOI. Do not deduct mortgage payments or income taxes when calculating this metric.

Cap rate = annual NOI ÷ purchase price × 100.

A $200,000 rental with $15,240 of annual NOI has a 7.62% cap rate. Financing it differently does not change that cap rate if price and operating assumptions stay the same.

For a purchase, use the price you expect to pay. For a current holding, market value can help you evaluate the operating yield on the asset today. State which denominator you used; yield on an old purchase price answers a different question.

How to calculate cash-on-cash return

Add the cash needed for the down payment, closing costs and cash-funded improvements. If you include an initial reserve balance in invested cash, include it consistently when comparing deals. Subtract debt service from NOI to calculate pre-tax cash flow.

Cash-on-cash return = annual pre-tax cash flow ÷ cash invested × 100.

Using the same hypothetical rental, assume a $50,000 down payment, $6,000 of closing costs and $5,000 of initial work: $61,000 invested. A $150,000 loan at an illustrative 7.5% over 30 years costs about $1,048.82 per month.

Annual NOI of $15,240 minus about $12,585.86 in debt payments leaves approximately $2,654.14. Divide that by $61,000 and the cash-on-cash return is 4.35% before a capital reserve.

If you set aside another $1,200 per year for major replacements, cash available falls to about $1,454.14, or 2.38% of invested cash after that reserve. Both calculations are useful when labeled clearly. Do not compare a return that includes a reserve with one that silently omits it.

Why a higher cap rate may still produce weak cash flow

Debt payments can consume much of the operating income. Financing fees also increase the cash you need to invest. Two buyers can purchase the same building at the same price and have different cash returns because of their down payments, interest rates and amortization periods.

Leverage can improve a percentage return in some cases while reducing the dollars left each month and increasing exposure to vacancy or refinancing risk. A higher cash-on-cash percentage does not automatically mean a safer investment.

What neither metric tells you

• Condition: an overdue roof replacement can make an attractive cap rate misleading.
• Liquidity: a percentage return does not tell you how much emergency cash remains after closing.
• Future value: neither measure guarantees appreciation or resale proceeds.
• Workload: neither automatically compensates you for self-management or renovation labor.
• Taxes: pre-tax cash return is not the same as after-tax profit.

Which number should you use when comparing deals?

Use cap rate to compare operating performance, then cash-on-cash return to compare the financing and capital required. Also look at monthly cash remaining, major repair needs and debt coverage. The DSCR calculator can help you examine coverage, but ask your lender which income and expense definition it uses.

Keep rent, vacancy, management and repair assumptions consistent across properties. If you use current market rent for one property and contracted rent for another, explain the difference.

Is a particular cap rate or cash-on-cash return “good”?

Judge it against similar properties, credible alternatives for your money and the risks you are taking. A rental with stable occupancy and less deferred work may justify a different return target than a difficult renovation. Set your criteria before the listing photographs influence the decision.

Calculate your cash-on-cash return

Educational guide. Examples are illustrative and depend on your inputs. Check property-specific costs and applicable requirements before acting.