Cap rate vs. cash-on-cash — which matters?
Both, but they answer different questions. A cap rate measures the property’s unleveraged return — NOI divided by price — independent of financing. Cash-on-cash measures your return — annual pre-tax cash flow divided by the cash you actually invested. Cap rate values the asset; cash-on-cash tells you how your money performs after the loan.
Cap rate: the property’s return
A cap rate is NOI ÷ price. It’s unleveraged — it ignores financing entirely — which is exactly why it’s so useful for valuing an asset and comparing deals apples-to-apples.
Cash-on-cash: your return
Where a cap rate describes the building, cash-on-cash describes your money — what your actual out-of-pocket investment earns each year once the loan is paid.
The difference is leverage
Financing doesn’t change a cap rate, but it dramatically changes cash-on-cash. Watch the same property with a loan:
| Price | $2,000,000 |
| NOI (7% cap rate) | $140,000 |
| Loan: 65% LTV at 6% (interest-only) → debt service | −$78,000 |
| Annual pre-tax cash flow | $62,000 |
| Cash invested (35% down) | $700,000 |
| Cash-on-cash return ( $62,000 ÷ $700,000 ) | 8.9% |
The property’s cap rate is 7%, but because the borrowing rate (6%) is below the cap rate, leverage lifts the investor’s cash-on-cash to about 8.9%. That’s positive leverage. Flip it — borrow above the cap rate — and leverage drags your return below the cap rate (negative leverage). Closing costs are excluded here for simplicity; adding them would modestly lower the return.
So which should you use?
- Cap rate to value a property and compare deals on an even footing.
- Cash-on-cash to judge how your specific investment — with your financing — performs in year one.
- Neither is your total return. Both ignore appreciation, loan paydown, and taxes. For the full picture over a hold period, investors use IRR.