Two metrics dominate rental property analysis: cap rate and cash-on-cash return. New investors often confuse them—or worse, use them interchangeably. They measure different things, and understanding when to use each will make you a better investor.

The Key Difference in One Sentence

Cap rate measures the property's yield as if you paid all cash.

Cash-on-cash return measures your actual return on the cash you invested.

Cap rate tells you about the property. Cash-on-cash tells you about your investment.

The Formulas

Cap Rate = Net Operating Income ÷ Property Value × 100

Cash-on-Cash Return = Annual Cash Flow ÷ Total Cash Invested × 100

The critical distinction: cap rate ignores how you finance the property, while cash-on-cash incorporates your mortgage payments.

Same Property, Different Numbers

Let's analyze a property both ways:

Property:

• Price: $500,000
• Annual NOI: $35,000
• Down payment (25%): $125,000
• Closing costs: $10,000
• Total cash invested: $135,000
• Annual mortgage payments: $28,500 (on $375,000 loan at 7%)

Cap Rate:

$35,000 ÷ $500,000 = 7.0%

Cash-on-Cash Return:

Cash flow = $35,000 - $28,500 = $6,500

$6,500 ÷ $135,000 = 4.8%

Same property. Cap rate is 7%. Cash-on-cash is 4.8%. Neither is "wrong"—they're answering different questions.

When to Use Each Metric

Use Cap Rate When:

Comparing properties regardless of financing

You're evaluating three apartment buildings. Each owner financed them differently—one paid cash, one has a high-interest loan, one used seller financing. Cap rate lets you compare apples to apples.

Estimating property value

If similar properties trade at 6% cap rates, and your target generates $50,000 NOI, it's worth approximately $833,000 ($50,000 ÷ 0.06).

Analyzing market trends

Rising cap rates indicate falling prices (or rising risk). Falling cap rates indicate rising prices. Tracking cap rate movements helps you understand market cycles.

Quick screening

Before diving into detailed analysis, cap rate tells you if a property is in the right ballpark. A 3% cap rate in a market where everything trades at 6% signals potential overpricing.

Use Cash-on-Cash When:

Evaluating your actual return

You care about what you'll earn on the money you invest. Cash-on-cash tells you exactly that—your yield on invested capital.

Comparing financing options

Same property, different loan terms. A 5.5% rate versus 7.5% rate dramatically changes cash-on-cash return. This metric helps you see the impact of financing choices.

Setting investment thresholds

Most investors have a minimum acceptable return. "I need at least 8% cash-on-cash" is a practical hurdle rate. Cap rate can't tell you if you'll hit your personal threshold.

Analyzing leveraged deals

Leverage amplifies returns (and risk). Cash-on-cash shows how leverage affects your actual return, while cap rate stays constant regardless of leverage.

How Financing Changes the Picture

Here's where things get interesting. Let's see how different down payments affect both metrics for the same $500,000 property (7% cap rate, 7% interest rate):

Cap rate stays at 7% in all scenarios. It doesn't care how you finance.

Cash-on-cash drops as leverage increases. Why? Because at 7% interest, your debt costs more than the property yields. You're borrowing at 7% to buy an asset yielding 7%—no arbitrage there.

Now let's see what happens if interest rates were 4%:

At 4% interest, leverage *boosts* cash-on-cash because you're borrowing cheaply to buy a higher-yielding asset. This is positive leverage.

The principle: When your cap rate exceeds your interest rate, leverage increases cash-on-cash return. When your interest rate exceeds your cap rate, leverage decreases cash-on-cash return.

The Current Rate Environment

In 2020-2021 with 3-4% rates, investors commonly saw cash-on-cash returns exceeding cap rates due to positive leverage.

In 2023-2025 with 6-8% rates, many deals show cash-on-cash returns *below* cap rates—sometimes even negative. The property might be fundamentally sound (decent cap rate), but financing costs make current cash flow unattractive.

This doesn't mean these are bad investments. If you expect:

• Rents to grow faster than expenses
• Property values to appreciate
• Interest rates to fall (enabling refinancing)

...then a low or negative cash-on-cash might still produce strong total returns. But you're betting on the future rather than current income.

Common Mistakes

Mistake 1: Using Cap Rate to Evaluate Leveraged Deals

Investor says: "This property has an 8% cap rate, that's a great return!"

Reality: After financing, their cash-on-cash is 3%.

Cap rate tells you nothing about your actual return when you use a mortgage.

Mistake 2: Ignoring Cap Rate When Comparing Properties

Investor says: "Property A has 10% cash-on-cash and Property B has 6%. Property A is better."

Reality: Property A might be in a declining market with high vacancy risk. Property B might be in a prime location with strong appreciation potential. Cash-on-cash alone doesn't capture risk or growth.

Mistake 3: Chasing High Numbers Without Understanding Why

A 12% cap rate or 15% cash-on-cash should trigger questions, not excitement. High returns typically signal high risk—deferred maintenance, declining area, or problematic tenants.

Mistake 4: Comparing Different Property Types

A 5% cap rate on a Class A multifamily in a gateway market isn't comparable to a 5% cap rate on a Class C retail property in a tertiary market. Risk profiles are completely different.

A Framework for Using Both Metrics

Step 1: Screen with cap rate

Is the property in a reasonable range for its type and market? If similar properties trade at 5-6% cap rates and this one is 4%, why?

Step 2: Evaluate with cash-on-cash

Does this deal meet your return requirements based on your actual investment and financing? Will you have positive cash flow?

Step 3: Consider total return

Neither metric captures appreciation, principal paydown, or tax benefits. A low cash-on-cash deal might still generate strong total returns.

Step 4: Assess risk

High cap rate = higher risk. Make sure you're being compensated for the risks you're taking.

Quick Reference

Key Takeaways

• Cap rate = NOI ÷ Property Value (ignores financing)
• Cash-on-cash = Cash Flow ÷ Cash Invested (includes financing)
• Cap rate is about the property; cash-on-cash is about your investment
• Use cap rate to compare properties and assess market value
• Use cash-on-cash to evaluate your actual return on invested capital
• Leverage increases cash-on-cash when rates are below cap rate, decreases it when above
• Always use both metrics together for complete analysis

Understanding when to use each metric—and what each reveals—separates sophisticated investors from those flying blind. Cap rate and cash-on-cash are partners, not competitors. Use them together.