Two of the most common metrics in real estate investing are cap rate and cash-on-cash return. While both measure profitability, they serve different purposes and are calculated differently. Understanding the distinction helps investors make better-informed decisions.

What is Cap Rate?

Cap rate measures the unleveraged return on a property. It ignores financing and focuses purely on the property’s income relative to its value. It is calculated as NOI divided by property value.

What is Cash-on-Cash Return?

Cash-on-cash return measures the return on the actual cash invested, accounting for financing. It is calculated as annual pre-tax cash flow divided by total cash invested, including down payment and closing costs.

Key Differences

• Financing: Cap rate ignores debt; cash-on-cash includes mortgage payments
• Purpose: Cap rate compares properties regardless of financing; cash-on-cash evaluates specific investment scenarios
• Formula: Cap Rate = NOI / Value; Cash-on-Cash = Annual Cash Flow / Cash Invested

Which One Should You Use?

Use cap rate to compare properties in the same market. Use cash-on-cash return to evaluate whether a specific financing structure makes sense for your investment goals. Most experienced investors look at both metrics before making a decision.