real-estate
Cap Rate vs. Cash on Cash: Which Metric Should You Trust?
The two most-cited real estate investment metrics measure different things. Use both — and know which one matters when.
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The formulas
- Cap rate = NOI ÷ purchase price
- Cash on cash = annual cash flow ÷ total cash invested
They sound similar. They tell you very different things.
What cap rate actually measures
Cap rate is a valuation metric. It tells you what yield a property would produce if you paid all cash and had no mortgage. It's used to:
- Compare similar properties on equal footing
- Estimate property value from NOI (price = NOI ÷ market cap rate)
- Compare submarkets and asset classes
Cap rate doesn't know about your financing. The same property has the same cap rate whether you put 25% down or pay all cash.
What cash on cash measures
Cash on cash is your personal yield. It accounts for:
- How much you actually put in (down payment + closing + rehab)
- What you actually keep (cash flow AFTER the mortgage payment)
The same property can have a 6% cap rate but produce a 15% cash-on-cash return if you use leverage well — or negative cash flow if you over-leverage.
When to use which
- Buying/selling decisions — cap rate. Compare against market cap rates in the area.
- Comparing your actual deals — cash on cash. This is what hits your bank account.
- Refinancing analysis — both. Cap rate is fixed; cash on cash shifts dramatically with new financing.
- Lender conversations — cap rate + DSCR (debt service coverage ratio). Lenders rarely care about your cash on cash.
A worked example
A $500K duplex with $40K NOI:
- Cap rate = $40K ÷ $500K = 8%
Two financing scenarios:
| All cash | 25% down | |
|---|---|---|
| Cash invested | $500K | $135K (down + closing + reserves) |
| Annual cash flow | $40K | $12K (after $28K mortgage) |
| Cash on cash | 8% | 8.9% |
Now with a higher rate that pushes mortgage to $35K/year:
| All cash | 25% down | |
|---|---|---|
| Cash invested | $500K | $135K |
| Annual cash flow | $40K | $5K |
| Cash on cash | 8% | 3.7% |
Same property. Same cap rate. Wildly different cash on cash.
Bottom line
Cap rate tells you about the property. Cash on cash tells you about your investment in the property. Run both via the Cap Rate calculator and Cash on Cash calculator before committing.
One property, both metrics
A $400,000 rental producing $28,000 in net operating income.
Cap rate ignores how you paid for it:
28,000 / 400,000 = 7.0%
Cash on cash depends entirely on how you paid. With 25% down, a $300,000 loan at 6.75% over 30 years, and $8,000 in closing costs:
| Line | Amount |
|---|---|
| Cash invested (down payment + closing) | $108,000 |
| Net operating income | $28,000 |
| Annual debt service | $23,350 |
| Annual cash flow | $4,650 |
| Cash on cash return | 4.31% |
Buy the same property outright for $408,000 all-in and cash on cash becomes 6.86% — higher, because there is no debt service, but on nearly four times the capital.
The two numbers disagree because they answer different questions. The cap rate says this is a 7% asset. Cash on cash says your particular financing turns it into a 4.31% cash yield on the money you actually put in.
When each one misleads you
Cap rate misleads when NOI is fiction. It is only as good as the expense assumptions beneath it. Sellers routinely present a cap rate that omits property management (8-10% of rent), capital reserves, and realistic vacancy. Add those back and a 7.5% cap becomes something closer to 5.5%. Rebuild NOI yourself from actual expenses, never from the offering memorandum.
Cash on cash misleads because leverage cuts both ways. Above, financing lowered the return. Borrow at a rate below the cap rate and the reverse happens — that is positive leverage, and it is the whole mechanism behind buying property with debt. Borrow above the cap rate and leverage destroys return, which is exactly what caught buyers when rates rose faster than cap rates did.
The rule: if your loan constant exceeds the cap rate, leverage is working against you. No amount of appreciation optimism changes the first year's arithmetic.
Neither captures the return that usually dominates. Principal paydown and appreciation are excluded from both. A deal at 4.31% cash on cash can still produce a low-teens total return once amortisation and modest appreciation are counted. Cash on cash is a liquidity measure, not a performance measure.
Cap rate compression, and why it decides your exit
Cap rate and value move inversely: Value = NOI / Cap Rate. Buy at a 7% cap,
and if market caps fall to 6% the same $28,000 NOI is worth $466,667 instead
of $400,000 — a $66,667 gain with no operational change. If caps rise to 8%,
that NOI is worth $350,000 and you have lost $50,000 while running the
property perfectly.
This is why underwriting an exit cap at or above your entry cap is the conservative convention. Assuming compression is assuming the market does your work for you.
Which to use when
- Comparing properties in one market → cap rate. It strips out financing so you compare assets, not loans.
- Deciding whether a specific deal works for you → cash on cash, with your actual rate, down payment and closing costs.
- Comparing against stocks or bonds → neither alone. Use total return including amortisation and a realistic appreciation assumption.
- Evaluating a value-add project → both, at purchase and at stabilisation. The gap between them is the deal.
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