Cap Rate vs Cash on Cash Return: The Property vs Your Deal

Cap rate is net operating income divided by price. Cash on cash return is cash flow after the mortgage divided by the cash you invested. The first measures the property. The second measures your deal.

Buy for cash and they are nearly the same number. Add a loan and they separate. The size and direction of the gap tells you whether borrowing is helping or hurting.

The two formulas

Cap rate = NOI / purchase price

Cash on cash return = (NOI − annual debt service) / cash invested

Both start with net operating income. Cap rate divides it by the price. Cash on cash subtracts a year of mortgage payments, then divides what is left by the down payment, closing costs and repairs you paid.

One property, four financing choices

A $300,000 rental with $18,270 of NOI. Cap rate: 6.1%. Closing costs of $9,000 in every case.

All cash. Cash invested $309,000. Cash flow is the full $18,270. Cash on cash: 5.9%. Slightly under the cap rate because closing costs are in the denominator.

25% down at 7.25%. Loan $225,000, payments $18,419 a year. Cash flow: $18,270 minus $18,419, negative $149. Cash on cash: −0.2% on $84,000 invested.

25% down at 5%. Same loan, payments $14,494. Cash flow $3,776. Cash on cash: 4.5%.

25% down at 3.5%. Payments $12,124. Cash flow $6,146. Cash on cash: 7.3%.

Same property, same 6.1% cap rate. Cash on cash returns from negative to 7.3%. Nothing about the building changed. The cost of money did.

The rule that decides the gap

Whether the financed return lands above or below the all-cash return depends on one comparison: the loan’s annual cost against the cap rate.

The loan’s annual cost is a year of payments divided by the balance, called the mortgage constant. It includes principal, so it runs above the interest rate. At 7.25% over 30 years it is about 8.2%. At 5% it is about 6.4%. At 3.5% it is about 5.4%.

Cap rate above the constant: each borrowed dollar earns more than it costs, and cash on cash rises above the cap rate. Positive leverage.

Cap rate below the constant: each borrowed dollar costs more than it earns, and cash on cash falls below the cap rate. Negative leverage. More borrowing makes it worse.

In the example, a 6.1% cap rate is below the 8.2% constant at 7.25%, so financing drags the return to zero. It is above the 5.4% constant at 3.5%, so financing lifts it. This is why the same house was a good leveraged investment in 2021 and a poor one in 2024.

When to use cap rate

To judge price. If comparable properties trade at 6% and a listing pencils to 7% on honest expenses, it is cheap. At 5%, it is dear. Financing is irrelevant to that question.

To compare properties. Different prices, sizes and locations become comparable when financing is stripped out.

To value income. NOI divided by the market cap rate is the appraiser’s income approach. Every $1,000 of NOI is worth about $16,700 at a 6% cap rate. The valuation guide goes into it.

To talk to the market. Brokers, appraisers and commercial lenders quote cap rates. Cash on cash is a buyer’s private number.

When to use cash on cash return

To decide whether you can hold the property. Cash on cash is the return on your actual money after the actual mortgage. Negative means you write a check every month, whatever the cap rate says.

To compare financing. Twenty percent down, twenty-five, all cash, interest-only, a rate buydown: each produces a different cash on cash return on the same property. Cap rate cannot see the difference.

To compare against other uses of the cash. Whether $84,000 belongs in this property or somewhere else is a cash on cash question.

Where each one misleads

Cap rate ignores financing, so a property with a fine cap rate can be unaffordable at today’s rates. It is also only as good as the NOI behind it. Listing pro formas routinely omit vacancy, management and reserves, adding one to two points.

Cash on cash ignores the asset’s value and the loan’s paydown. A heavily leveraged deal with thin cash flow may still build equity quickly. An all-cash deal with a healthy cash yield may be tying up capital that could earn more elsewhere. And it is a single-year snapshot that does not know rents will rise or the interest-only period will end.

Using them together

Compute the cap rate first, on honest expenses, and compare it to recent sales. That tells you whether the price is fair.

Then compare the cap rate to your loan’s constant. Above it, borrowing helps and you can consider less down. Below it, borrowing hurts and the question is how much negative leverage you are willing to carry for the appreciation and paydown.

Then compute cash on cash on your actual financing. That tells you whether you can hold it.

The cap rate calculator handles the first step and the value math. For the leveraged return on your own cash, a cash on cash calculator takes the same NOI and adds the loan.