Cap Rate vs. Cash-on-Cash Return
Both measure rental returns, but they answer different questions.
Cap rate: how good is the property?
Cap rate = net operating income ÷ purchase price
Net operating income (NOI) is rent minus vacancy and operating expenses, before any loan payment. Because it ignores financing, cap rate lets you compare properties fairly. A $250,000 home with $15,000 of NOI has a 6% cap rate.
Cash-on-cash: how good is your investment?
Cash-on-cash return = yearly cash flow after loan payments ÷ cash you invested
If you put $60,000 into that home and it cash flows $4,200 a year after the mortgage, your cash-on-cash return is 7%. Financing can raise or lower it compared with the cap rate.
Which one should I use?
- Use cap rate to compare properties and judge the price.
- Use cash-on-cash to compare your deal with other uses of your money.
- Use DSCR to see whether the rent covers the loan the way a lender measures it.