When you finance a rental property with a mortgage, cap rate only tells half the story. You need a metric that accounts for your actual cash investment—not the total property value. That's where cash-on-cash return comes in.

Cash-on-cash return is one of the most practical metrics for evaluating leveraged real estate deals. It tells you exactly what percentage return you're earning on the cash you've actually invested.

What is Cash-on-Cash Return?

Cash-on-cash return (CoC) measures the annual pre-tax cash flow relative to the total cash invested in a property. It answers a simple question: "What's my return on the money I put in?"

Unlike cap rate, which ignores financing, cash-on-cash return accounts for your down payment, closing costs, and mortgage payments. This makes it far more relevant for investors who use leverage.

The Cash-on-Cash Formula

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

Where:

• Annual Pre-Tax Cash Flow = NOI minus annual debt service (mortgage payments)
• Total Cash Invested = Down payment + closing costs + renovation costs

Breaking Down Cash Flow

Annual Pre-Tax Cash Flow = Gross Rental Income - Vacancy - Operating Expenses - Mortgage Payments

Operating expenses include property taxes, insurance, maintenance, property management, and other recurring costs—but not your mortgage principal or interest.

Example Calculation

Let's walk through a real example:

Property Details:

• Purchase price: $400,000
• Down payment (25%): $100,000
• Closing costs: $8,000
• Renovation: $12,000
• Total cash invested: $120,000

Annual Income:

• Gross rent: $36,000 ($3,000/month)
• Vacancy (5%): -$1,800
• Effective gross income: $34,200

Annual Expenses:

• Property taxes: $4,000
• Insurance: $1,500
• Maintenance: $2,000
• Property management (8%): $2,736
• Other expenses: $1,000
• Total operating expenses: $11,236

NOI: $34,200 - $11,236 = $22,964

Debt Service:

• Loan amount: $300,000
• Interest rate: 7%
• 30-year term
• Annual mortgage payments: $23,940

Annual Cash Flow: $22,964 - $23,940 = -$976

Cash-on-Cash Return: -$976 ÷ $120,000 = -0.8%

Wait—this property has negative cash flow? At a 7% interest rate, yes. This is exactly why cash-on-cash matters. The property might have looked attractive based on cap rate alone (5.7%), but when you factor in financing costs at current rates, the actual cash return is negative.

Same Property, Different Financing

Now let's see what happens with a lower interest rate:

At 5% interest:

• Annual mortgage payments: $19,320
• Annual cash flow: $22,964 - $19,320 = $3,644
• Cash-on-cash return: $3,644 ÷ $120,000 = 3.0%

At 4% interest:

• Annual mortgage payments: $17,184
• Annual cash flow: $22,964 - $17,184 = $5,780
• Cash-on-cash return: $5,780 ÷ $120,000 = 4.8%

Interest rates dramatically impact cash-on-cash returns. A deal that works at 5% might not work at 7%.

What's a Good Cash-on-Cash Return?

Most investors target a minimum cash-on-cash return of 8-12% for rental properties, though expectations vary based on:

Market conditions:

• In low-rate environments (2020-2021), 8-10% was achievable in many markets
• In higher-rate environments (2023-2025), many investors accept 4-6% or focus on appreciation

Property type:

• Turnkey single-family: 4-8%
• Value-add multifamily: 8-15%+ (after stabilization)
• Commercial properties: Varies widely by asset class

Investment strategy:

• Cash flow investors: Want higher CoC (10%+)
• Appreciation investors: Accept lower CoC (0-5%) in high-growth markets

Your opportunity cost:

If you can earn 5% risk-free in a high-yield savings account, a rental property should offer meaningfully higher returns to compensate for the work, risk, and illiquidity involved.

Cash-on-Cash vs. Cap Rate

Both metrics are useful. Cap rate helps you compare properties regardless of how they're financed. Cash-on-cash tells you what you'll actually earn on your money.

Limitations of Cash-on-Cash Return

1. Only Measures Year One

Cash-on-cash is typically calculated for the first year of ownership. It doesn't account for:

• Rent increases over time
• Mortgage paydown (building equity)
• Property appreciation
• Future capital expenditures

A property with 4% year-one cash-on-cash might yield 8%+ by year five if rents grow faster than expenses.

2. Pre-Tax Only

Cash-on-cash doesn't factor in tax benefits like depreciation, which can significantly improve after-tax returns. Real estate often provides better after-tax returns than the headline cash-on-cash suggests.

3. Ignores Total Return

Your real estate returns come from:

• Cash flow (measured by CoC)
• Principal paydown (your tenants pay down your loan)
• Appreciation (property value increases)
• Tax benefits (depreciation, deductions)

Cash-on-cash only captures the first component. A property with low cash-on-cash but strong appreciation potential might outperform one with high cash-on-cash but flat values.

How to Improve Cash-on-Cash Return

Increase Income

• Raise rents to market rate
• Add income sources (laundry, parking, storage)
• Reduce vacancy through better tenant screening and retention

Decrease Expenses

• Shop insurance annually
• Contest property tax assessments
• Self-manage if you have time/skills
• Negotiate with vendors

Optimize Financing

• Put less money down (increases CoC but also risk)
• Refinance when rates drop
• Use interest-only periods on commercial loans

Buy Right

• Negotiate purchase price below market
• Find off-market deals
• Target properties with fixable issues (deferred maintenance, under-market rents)

Key Takeaways

• Cash-on-cash return = Annual cash flow ÷ Total cash invested
• It measures your actual return on invested capital, including financing
• Most investors target 8-12%, but acceptable returns vary with market conditions
• Interest rates significantly impact cash-on-cash returns
• Use cash-on-cash alongside cap rate and other metrics for complete analysis
• Remember: cash-on-cash only captures one component of total real estate returns

Cash-on-cash return keeps you grounded in reality. It doesn't matter what a property *could* return if you paid all cash—what matters is what it *will* return based on your actual investment. Make sure the numbers work before you sign.