Cap Rate vs. Cash-on-Cash Return: Formulas and a Worked Example
Cap rate and cash-on-cash return both describe a rental's income as a percentage, but they answer different questions. Cap rate looks at the property as if you paid cash. Cash-on-cash looks at your cash flow after the mortgage, compared with the cash you actually put in.
The formulas (as the Rental Deal Analyzer computes them)
Effective gross income (EGI) = GSI × (1 − vacancy %)
Operating expenses = property tax + insurance + (HOA + owner utilities) × 12 + monthly rent × 12 × (maintenance % + CapEx % + management %)
NOI = EGI − operating expenses
Cap rate = NOI ÷ purchase price
Annual debt service = monthly P&I × 12
Cash flow = NOI − annual debt service
Total cash invested = down payment + closing costs + upfront repairs
Cash-on-cash return = annual cash flow ÷ total cash invested
Notes on these definitions, which can differ from other sources:
- Vacancy is inside NOI (via effective gross income).
- The mortgage is not an operating expense, so NOI and cap rate ignore financing.
- Maintenance, CapEx and management are % of rent only (monthly rent × 12, before vacancy, not including other income).
- Cap rate uses purchase price, not price plus closing costs or repairs.
- Cash invested includes closing costs and upfront repairs, not just the down payment. Loan fees or reserves are only included if you add them into closing costs.
- Cash flow here is before income taxes; principal paydown and appreciation are not counted.
Worked example
Example only: made-up round numbers, not a real property or market. Purchase price $200,000; monthly rent $1,800 (no other income); closing costs $6,000; upfront repairs $4,000; 20% down; 7% interest, 30-year loan; 5% vacancy; property tax $2,400/yr; insurance $1,200/yr; no HOA or owner-paid utilities; maintenance 8% and CapEx reserve 5% of rent; self-managed (0%).
- GSI: $1,800 × 12 = $21,600
- EGI: $21,600 × (1 − 0.05) = $20,520
- Operating expenses: $2,400 + $1,200 + $0 + $21,600 × (0.08 + 0.05) = $3,600 + $2,808 = $6,408
- NOI: $20,520 − $6,408 = $14,112
- Cap rate: $14,112 ÷ $200,000 = 7.06% (0.07056)
- Loan: $200,000 × (1 − 0.20) = $160,000. Monthly P&I at 7% for 30 years ≈ $1,064.48, so annual debt service ≈ $12,773.81
- Cash flow: $14,112 − $12,773.81 ≈ $1,338.19 per year (about $111.52 per month)
- Cash invested: $40,000 down + $6,000 closing + $4,000 repairs = $50,000
- Cash-on-cash: $1,338.19 ÷ $50,000 ≈ 2.68%
Same property, two very different percentages. The cap rate is higher because it ignores the mortgage; the cash-on-cash return is lower here because the loan payment takes most of the NOI. With a different rate, down payment or price, the gap changes.
When to look at which
- Cap rate compares properties on the same basis regardless of how each is financed.
- Cash-on-cash reflects your actual loan and the cash you put in.
- Neither includes taxes, appreciation or principal paydown, and both are only as good as your expense estimates.
To check whether NOI covers the loan payments, see DSCR for rental property.
For the monthly cash flow figure step by step, see how to calculate rental property cash flow.
For a quick rent-versus-price screen before running these numbers, see The 1% Rule for Rental Properties. Keeping real expense records makes the inputs better: rental property expense categories.
Not investment advice. These are estimates that depend entirely on the numbers you enter. Check figures with your lender and a qualified professional before you buy. Not legal or tax advice; rules vary by state and city.