Cap Rate Calculator

Cap rate vs. cash-on-cash return: which one should you use?

Two numbers come up in almost every conversation about rental property: the cap rate and the cash-on-cash return. They look similar — both are percentages, both compare income with money — but they answer different questions. Mixing them up is one of the most common reasons why investors overpay or turn down a good deal.

The short answer

  • The cap rate tells you how much income the property produces relative to its price, as if you bought it with cash.
  • The cash-on-cash return tells you how much cash you receive each year relative to the cash you put in, after paying the loan.

Use the cap rate to compare properties with each other. Use the cash-on-cash return to judge whether a specific purchase, with a specific loan, works for you.

How each one is calculated

The cap rate divides the yearly net operating income (NOI) by the price:

Cap rate = NOI ÷ price × 100%

NOI is rent and other income, minus vacancy and operating expenses. Loan payments are not part of it.

The cash-on-cash return starts from the same NOI but subtracts the yearly loan payments first, and divides by the cash you actually invested — usually the down payment plus closing costs:

Cash-on-cash return = (NOI − yearly loan payments) ÷ cash invested × 100%

One property, two answers

Take the worked example from our calculator: a house bought for 250,000 that produces 16,140 of NOI a year. Its cap rate is 6.46%, whoever buys it.

Now suppose the buyer pays 25% down, borrows the rest at 6.5% over 30 years and pays 7,500 in closing costs. The loan payments come to roughly 14,200 a year, which leaves about 1,900 of cash flow. Divided by the 70,000 of cash invested, that is a cash-on-cash return of around 2.7% — far below the cap rate.

A second buyer who pays cash has no loan payments. Their cash flow is the full 16,140, and their cash-on-cash return is close to the cap rate.

Same building, same cap rate, very different results for the two owners. That is exactly why the cap rate leaves financing out: it lets you compare buildings without mixing in each buyer's loan.

Positive and negative leverage

Borrowing increases your cash-on-cash return only when the property earns more than the loan costs. A quick test is to compare the cap rate with the interest rate:

  • If the cap rate is above the loan's interest rate, leverage tends to be positive: borrowing more raises your cash-on-cash return.
  • If the cap rate is below the interest rate, leverage tends to be negative: each borrowed unit costs more than it earns, and your cash-on-cash return falls.

In the example above, a 6.46% cap rate and a 6.5% interest rate are almost equal, and the principal repayments built into a 30-year loan push the cash flow down further. The result is a thin cash flow and a low debt service coverage ratio (DSCR) of about 1.13 — something a lender will look at closely.

Which one should you use?

Use both, in this order:

  1. Screen with the cap rate. It is quick, independent of financing and comparable across properties. If the cap rate is out of line with similar properties, find out why before going further.
  2. Decide with the cash-on-cash return and DSCR. Once a property passes the first screen, add your actual loan terms. Check that the cash flow is positive with a safety margin and that the DSCR meets your lender's requirements.

Remember that neither number captures everything. Both describe a single year; neither includes future rent growth, changes in value or the repayment of the loan, which is a form of saving. For a longer view, investors model the whole holding period.

Try it with your own numbers

Our cap rate calculator shows the cap rate and gross rent multiplier first. Add a down payment, interest rate, loan term and closing costs in the financing section, and it also shows the loan payment, the monthly and yearly cash flow, the cash-on-cash return and the DSCR — side by side, so you can see how the loan changes the picture.

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