Cap Rate vs Cash-on-Cash Return: When to Use Each Metric

Quick Answer

Cap rate measures the property’s unlevered yield — what it earns regardless of how you pay for it. Cash-on-cash return measures your personal return on the cash you actually invested. Same property, different questions. Use cap rate to compare properties and markets. Use cash-on-cash to evaluate how your specific financing structure affects your personal return. Both metrics are essential parts of real estate investment analysis.

What Is Cap Rate?

Capitalization rate (cap rate) divides a property’s net operating income (NOI) by its purchase price or current market value. It answers: “What annual yield does this property produce, ignoring financing?”

Cap Rate = NOI ÷ Purchase Price

A property with $18,000 in NOI purchased for $250,000 has a 7.2% cap rate. This number is independent of your down payment, mortgage rate, or loan term. It is a property-level metric.

Cap rates serve as the real estate equivalent of an earnings yield in stocks. They let you compare properties of different sizes and price points on a level playing field. Use the cap rate calculator to evaluate properties you are considering.

Typical cap rates for residential investment properties in the U.S. range from 4% to 8%, depending on market, property type, condition, and location. Class A properties in strong markets trade at lower cap rates (4-5%) because they carry less risk. Value-add properties in secondary markets may trade at 7-8% or higher, reflecting additional risk and management effort.

What Is Cash-on-Cash Return?

Cash-on-cash return divides your annual pre-tax cash flow by the total cash you invested — down payment, closing costs, and any rehab expenses. It answers: “What return am I earning on the money I put in?”

Cash-on-Cash Return = Annual Pre-Tax Cash Flow ÷ Total Cash Invested

If you invest $65,000 in cash (down payment plus closing costs) and the property generates $5,200 per year in cash flow after all expenses and debt service, your cash-on-cash return is 8.0%. Use the cash-on-cash return calculator to compute this for your scenario.

Cash-on-cash return is an investor-level metric. Two investors buying the same property with different financing terms will have different cash-on-cash returns — even though the cap rate is identical.

The Key Difference: Property vs Investor Return

This is the core insight: cap rate evaluates the property; cash-on-cash evaluates the deal.

Cap rate strips out financing and measures what the asset itself produces. It is useful for comparing properties regardless of how they are funded. Cash-on-cash includes financing and measures what you personally earn on your equity. It is useful for comparing deals across different capital structures.

An all-cash buyer’s cash-on-cash return equals the cap rate (approximately — minor differences arise from how closing costs are allocated). Once leverage enters the picture, the two metrics diverge, sometimes dramatically.

When to Use Cap Rate

Comparing properties in the same market. Cap rate normalizes for property size and price, letting you compare a $150,000 duplex against a $400,000 fourplex on equal terms. The higher cap rate property generates more income per dollar of asset value.

Evaluating market pricing. Cap rates compress when demand increases (investors bid prices up relative to income). Tracking cap rate trends helps you understand whether a market is getting more expensive or more affordable for investors.

Analyzing an all-cash purchase. Without financing, cap rate is your return. Some investors — particularly those using 1031 exchanges or self-directed IRAs — purchase without leverage, making cap rate the primary performance metric.

Quick property screening. Before running a full financing analysis, cap rate tells you whether the property’s income justifies the price at a fundamental level. A 3% cap rate property in a market where comparable properties trade at 6% is either overpriced or has unusual characteristics worth investigating.

When to Use Cash-on-Cash Return

Evaluating leveraged investments. Most investors use mortgages. Cash-on-cash return measures how effectively your limited cash generates income when combined with borrowed capital.

Comparing financing scenarios. Should you put 20% down or 25%? A 30-year term or 15-year? Cash-on-cash return reveals how different loan structures affect your personal return. Sometimes a smaller down payment dramatically improves cash-on-cash return despite the higher monthly payment.

Setting personal return thresholds. Many investors have minimum cash-on-cash return requirements — often 8% to 12% for residential properties. This metric directly answers whether a deal meets your personal hurdle rate.

Comparing real estate to other investments. If your stock portfolio earns 10% annually, a rental property must deliver a competitive cash-on-cash return to justify the additional management effort and illiquidity.

How Financing Changes the Picture

Consider a $300,000 property with $21,000 NOI (7.0% cap rate). Compare two scenarios:

Scenario A: All cash

• Cash invested: $310,000 (price + closing costs)
• Annual cash flow: $21,000 (NOI = cash flow with no mortgage)
• Cash-on-cash return: 6.8%

Scenario B: 75% LTV mortgage at 7.0%, 30-year

• Cash invested: $85,000 (25% down + closing costs)
• Annual debt service: $17,962
• Annual cash flow: $21,000 − $17,962 = $3,038
• Cash-on-cash return: 3.6%

Same property, same cap rate — but the leveraged deal actually has a lower cash-on-cash return in this case. This happens when the mortgage interest rate (7.0%) equals the cap rate (7.0%). Leverage only amplifies returns when the cost of debt is below the cap rate.

Scenario C: Same property at 5.5% interest

• Annual debt service: $15,335
• Annual cash flow: $21,000 − $15,335 = $5,665
• Cash-on-cash return: 6.7%

At a lower interest rate, leverage becomes positive. The difference between the cap rate and the interest rate — called the spread — determines whether leverage helps or hurts. The DSCR calculator helps verify that financing is viable before optimizing for cash-on-cash return.

Using Both Metrics Together

The most effective analysis uses both metrics at different stages:

1. Screen with cap rate — Eliminate properties with unacceptable property-level yields. If the cap rate is too low for the market and risk profile, no amount of financing creativity will make it work.
2. Analyze with cash-on-cash — For properties that pass the cap rate screen, model your specific financing to determine whether the leveraged return meets your requirements.
3. Stress-test with both — Run scenarios with higher vacancy, lower rents, or higher interest rates. A property with a strong cap rate but marginal cash-on-cash return may not survive adverse conditions.

This two-metric approach prevents two common errors: buying a high-cap-rate property that cannot support financing (DSCR too low), and buying a low-cap-rate property in a hot market that only works with aggressive leverage assumptions.

Other Metrics to Consider

Cap rate and cash-on-cash return are essential but incomplete. A thorough analysis also includes:

• DSCR — Confirms the property qualifies for financing. Use the DSCR calculator to check lender requirements.
• Gross Rent Multiplier (GRM) — A fast screening ratio comparing price to gross rent. Use the GRM calculator for initial filtering.
• Cash flow — The absolute dollar amount you receive monthly, not just the percentage return. A 12% cash-on-cash return on a $20,000 investment is $2,400/year — which may or may not justify the management effort. Use the rental property cash flow calculator for detailed analysis.

The Rental Property Analyzer template combines all of these metrics in a single spreadsheet, letting you evaluate properties holistically rather than one metric at a time.