Cap rate vs cash-on-cash return
One describes the building. The other describes your position in it. The number that connects them is not the interest rate, which is why leverage sometimes does the opposite of what people expect.
The short version
Cap rate is NOI divided by price. It has no opinion about how you paid. Two buyers, one paying cash and one borrowing 75%, buy the same building at the same cap rate.
Cash-on-cash is the cash left after debt service, divided by the cash you put in. It is entirely about how you paid. Those same two buyers get completely different answers.
So they are not competing measures and there is no correct choice between them. Cap rate is how you compare assets and turn income into value. Cash-on-cash is how you decide whether this capital structure deserves your equity.
Worked on one deal
Sample inputs
- Purchase price
- $16,750,000
- Year-one NOI
- $1,209,604
- Loan
- $10,890,000
- Rate / amortization
- 6.50% / 30 yr
- Closing costs
- $335,000
- Total equity
- $6,195,000
A 184,500 SF industrial building, three leases in place and one suite dark. The same deal used throughout this site, so the figures here reconcile with the ones on the other pages.
Cap rate: 7.222%. $1,209,604 of NOI over the $16,750,000 price.
Cash-on-cash: 6.192%. Debt service is $825,987, so $383,617 of cash remains; $6,195,000 of equity went in.
One building, one year, two entirely legitimate numbers more than a point apart.
The part that surprises people
Borrowing more should lift cash-on-cash, because the same income is spread over less equity. On this deal, it does the opposite.
| LTV | Loan | Cap rate | Cash-on-cash |
|---|---|---|---|
| 55% | $9,212,500 | 7.222% | 6.489% |
| 65% | $10,887,500 | 7.222% | 6.193% |
| 75% | $12,562,500 | 7.222% | 5.677% |
The cap rate does not move, because the building did not change. The cash-on-cash falls from 6.489% to 5.677% as the loan grows — the reverse of the usual expectation.
The instinct says this cannot be right: the interest rate is 6.50% and the cap rate is 7.222%, so the money costs less than the asset earns. That test is the wrong one.
Compare the cap rate to the loan constant, not the rate
The loan constant is annual debt service divided by the loan amount. It is what a dollar of borrowing actually costs you in cash each year, and on an amortizing loan it is higher than the interest rate, because the payment includes principal.
Here: $825,987 of debt service on a $10,890,000 loan is a 7.585% constant — against a 7.222% cap rate. Every extra dollar borrowed costs 7.585 cents a year and buys an asset earning 7.222 cents. That is negative leverage, and it is why cash-on-cash falls as the loan rises.
The interest rate never entered into it. A 6.50% loan and a 7.585% constant are the same loan.
This is not an argument against borrowing. The principal in that payment is not lost — it is equity you are accumulating, and it comes back at the sale. It is an argument against judging leverage on cash-on-cash alone, and a reason IRR exists.
Questions people ask
What is the difference between cap rate and cash-on-cash return?
Cap rate is NOI divided by price and ignores your loan entirely — it describes the building. Cash-on-cash is the cash left after debt service divided by the cash you put in, so it describes your position in the building. Two buyers paying the same price for the same asset have the same cap rate and can have very different cash-on-cash returns.
Which one should I use?
Both, for different questions. Cap rate is how you compare one asset against another and how you translate income into value. Cash-on-cash is how you judge whether this particular capital structure is worth your equity. Neither answers the other's question.
Does more leverage always increase cash-on-cash return?
No, and the case where it does not is the one worth understanding. Leverage lifts cash-on-cash only when the loan costs less per dollar borrowed than the asset earns per dollar of price. The comparison is against the loan constant, not the interest rate — and on an amortizing loan those are different numbers.
What is a loan constant?
Annual debt service divided by the loan amount. On the deal below, a 6.50% loan amortizing over thirty years has a 7.585% constant, because the payment includes principal as well as interest. That 7.585% is what you compare against the cap rate.
Does cash-on-cash account for the sale?
No. It is a single year's cash return on a single year's basis, which makes it useful and incomplete. It says nothing about appreciation, amortization or the exit, all of which IRR does capture.
Keep reading
What is cap rate?
The measure of the building, on its own.
What is cash-on-cash return?
The measure of your position in it.
What is IRR?
The one that does account for the exit.
Cash-on-cash calculator
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Debt modeling
Where the loan constant shows up in the product.
CRE loan terms
Amortization, and why it changes the payment.
See both numbers on your own deal.
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