Cash-on-Cash Return vs. Cap Rate: Which Matters for Your Rental?
Short answer: Cap rate measures a property’s return as if you paid cash: net operating income divided by the price. Cash-on-cash return measures what your actual invested cash earns after mortgage payments: annual cash flow divided by cash invested. Use cap rate to compare properties and cash-on-cash to judge your deal and financing.
- Cap rate ignores financing; cash-on-cash includes it.
- When your mortgage rate is higher than the cap rate, borrowing can lower your cash-on-cash return.
- Neither includes appreciation, principal paydown or tax benefits.
- Both depend on realistic expense assumptions: vacancy, maintenance and management.
The formulas
Cap rate = annual net operating income (NOI) ÷ purchase price
Cash-on-cash return = annual pre-tax cash flow ÷ total cash invested
NOI is rent minus vacancy and operating expenses (property tax, insurance, HOA, management, maintenance), but before mortgage payments. Cash flow is NOI minus your mortgage payments. Cash invested is your down payment plus closing costs and any upfront repairs.
Worked example
A $300,000 rental rents for $2,400 a month. You put 25% down ($75,000), pay $6,000 in closing costs and $4,000 in repairs, and finance the rest at 7% for 30 years. Assume 5% vacancy, 8% management, maintenance of 1% of the value per year, $300/month property tax and $120/month insurance.
| Monthly | Amount |
|---|---|
| Rent | $2,400 |
| Less vacancy (5%) | −$120 |
| Less property tax, insurance | −$420 |
| Less management (8%) | −$192 |
| Less maintenance (1%/yr) | −$250 |
| Net operating income | $1,418 |
| Less mortgage payment ($225,000 at 7%) | −$1,496.93 |
| Cash flow | −$78.93 |
| Measure | Result |
|---|---|
| Cap rate ($17,016 NOI ÷ $300,000) | 5.67% |
| Cash-on-cash, 25% down (−$947 ÷ $85,000) | −1.11% |
| Cash-on-cash, all cash ($17,016 ÷ $310,000) | 5.49% |
The property earns a 5.67% cap rate, but financed at 7% it loses money each month. Paying cash would earn about 5.5% on your money. This is negative leverage: borrowing at a rate above the property’s cap rate drags down your return on cash.
When to use each
- Use cap rate to compare properties and markets on equal footing, and to sanity-check an asking price against local cap rates.
- Use cash-on-cash return to decide whether a specific deal (with your down payment and loan) is worth your cash compared with other investments.
- Look at both: a good cap rate with poor cash-on-cash usually means the financing, not the property, is the problem.
What is a good cap rate or cash-on-cash return?
There is no universal number. Cap rates are lower in expensive, fast-appreciating areas and higher in cheaper or riskier ones. Many small investors look for cash-on-cash returns in the high single digits or better, but what counts as good depends on interest rates, local appreciation, the property’s condition and how hands-on you want to be.
A useful rule of thumb: if the cap rate is below your mortgage rate, expect thin or negative cash flow unless you put more money down, buy for less, or raise rents.
What neither number captures
- Appreciation in the property’s value.
- Principal paydown: your tenants gradually paying off the loan.
- Tax benefits such as depreciation.
- Selling costs and taxes when you exit.
For the full picture over time, look at total return and when the property breaks even after selling costs and taxes.
Frequently asked questions
Is cash-on-cash return the same as ROI?
Cash-on-cash is one kind of ROI: it measures only annual cash flow relative to cash invested. Broader ROI measures can include appreciation, principal paydown and tax benefits.
Why does my cap rate look fine but my cash flow is negative?
Usually because your mortgage rate is higher than the cap rate, so debt payments eat more than the property earns on the borrowed portion. A larger down payment, a lower price or higher rent can fix it.
Does cap rate include the mortgage?
No. Cap rate uses net operating income before debt payments, so it is the same whether you pay cash or borrow.
Should closing costs be included in cash invested?
Yes. Cash-on-cash return should use all the cash you put in: down payment, closing costs and upfront repairs or improvements.
More guides
This guide explains general federal tax rules for educational purposes and is not tax, legal or financial advice. Rules change and depend on your situation. Consult a qualified tax professional before acting.