Cap rate and cash-on-cash return
Cap rate compares annual net operating income with property price or value, depending on the question. It excludes financing. Use consistent NOI definitions when comparing properties. A higher cap rate does not automatically mean a better investment; condition, location, management burden, and reliability matter.
Cash-on-cash return compares modeled annual pre-tax cash flow with cash invested. Include down payment, closing costs, initial repairs, and other equity contributions. Disclose how initial reserves are treated. Do not quietly exclude a large repair bill to make returns appear stronger.
Neither measure captures everything. Appreciation, tax effects, principal reduction, capital expenditures, and eventual selling costs require additional analysis. Use simple metrics to understand a deal, then examine the risks behind the inputs.
Annual NOI of $12,000 on a $150,000 price is an 8% cap rate. Annual cash flow of $3,000 on $40,000 invested is a 7.5% cash-on-cash return. These figures answer different questions.
Decision checklist
- State the NOI and cash-flow definitions you use.
- Include all initial equity contributions in the cash-invested denominator.
- Compare assumptions and risks before ranking properties by return.
Check your understanding
What is the difference between cap rate and cash-on-cash return?
Show the answer
Cap rate uses NOI relative to property price/value; cash-on-cash uses annual modeled cash flow relative to the investor’s cash contribution.
Your next action
Calculate both metrics using the same property. Explain why leverage changes cash-on-cash return but not unlevered NOI.
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