Cap Rate vs. Cash-on-Cash: Which Metric Actually Matters?

Two metrics dominate rental property analysis: cap rate and cash-on-cash ROI. They sound similar but they measure different things. Confusing them can lead to bad decisions.

Cap rate: the property's return

Cap rate ignores financing entirely. It is the return the property generates as if you paid all cash:

Cap rate = annual net operating income (NOI) ÷ purchase price

Both cap rate and cash-on-cash are calculated using annual figures, so your income and expense inputs should always reflect a full year of operations. It is useful for comparing properties to each other and to other asset classes. A 6% cap rate beats a 4% cap rate, all else equal. But "all else" is rarely equal.

Cash-on-cash: your return

Cash-on-cash ROI factors in your actual cash investment, usually just the down payment plus closing costs:

Cash-on-cash = annual cash flow ÷ total cash invested

This is what you actually earn on the money you put in. With leverage, cash-on-cash can be much higher than cap rate. That is the advantage of mortgage financing working in your favor.

The interplay

If cap rate is the property's return and cash-on-cash is your return, the gap between them is the value of leverage. A property with a 5% cap rate and a 12% cash-on-cash ROI is telling you that financing is doing a lot of heavy lifting.

Quick example

$300k property, $30k annual NOI, 25% down ($75k), $20k annual cash flow after debt service:

• Cap rate: 30,000 ÷ 300,000 = 10%
• Cash-on-cash: 20,000 ÷ 75,000 = 26.7%

What to use when

Use cap rate when comparing different properties or markets. Use cash-on-cash when deciding whether this specific deal is worth your money. Smart investors look at both.