Cap rate vs. cash-on-cash return, explained with one example

These two metrics get confused constantly, because they both describe how well a property performs — but they answer different questions, and can point in opposite directions on the exact same deal.

The example

Say you’re looking at a $400,000 property with $28,000 a year in net operating income (NOI) — rent after vacancy and operating expenses, before any mortgage payment.

Cap rate asks: if I paid all cash, what return would this income generate? That’s simply $28,000 ÷ $400,000 = 7%. It doesn’t matter how you actually plan to pay for the property — cap rate assumes an all-cash buyer every time.

Cash-on-cash return asks a completely different question: given how I’m actually financing this, what return am I getting on my actual cash? Say you put 25% down ($100,000) plus $8,000 in closing costs — $108,000 of your own cash. Your mortgage on the remaining $300,000 costs $19,000 a year in principal and interest. Your actual cash flow is $28,000 − $19,000 = $9,000. Cash-on-cash return is $9,000 ÷ $108,000 = 8.3%.

Same property, same income — a 7% cap rate and an 8.3% cash-on-cash return. The gap is entirely explained by leverage.

Why leverage can cut both ways

In the example above, borrowing helped, because the property’s return (its cap rate) exceeded the effective cost of the mortgage. When that relationship flips — when your interest rate is higher than the cap rate — leverage works against you, and cash-on-cash return drops below cap rate instead of rising above it. This is the single most important intuition to build about leveraged real estate: debt amplifies whatever the underlying deal was already doing, for better or worse.

Which one should you use?

Use cap rate to compare properties or markets independent of financing — it’s the cleaner apples-to-apples metric. Use cash-on-cash return to judge how a specific deal will perform with your specific loan terms, which is what actually determines your annual cash flow. Serious investors track both, on the same deal, side by side.

Try it yourself with the cap rate calculator and the cash-on-cash return calculator — or run the full picture at once in the property investment calculator.