Cap rate tells you what a property yields unlevered. Cash-on- cash return tells you what your actual cash yields. They're two different numbers for the same property, and both matter for different reasons.
The worked example
$300,000 property. $2,500/month rent. $500/month expenses.
Annual NOI = ($2,500 − $500) × 12 = $24,000. Cap rate = $24,000 / $300,000 = 8%.
Now add financing: 25% down ($75,000), 75% mortgage ($225,000) at 7% for 30 years = $1,497/month P&I.
Annual cash flow = $24,000 NOI − $17,964 mortgage = $6,036. Cash invested = $75,000 down + say $10,000 closing = $85,000. Cash-on-cash = $6,036 / $85,000 = 7.1%.
Wait — cap rate is 8% and cash-on-cash is 7%? That's because 7% mortgage rate is close to the 8% cap rate. At lower rates, leverage is more valuable.
When leverage wins
Replay at 4% mortgage rate. Same $225k loan → $1,074/month P&I. Annual cash flow = $24,000 − $12,888 = $11,112. Cash-on-cash = $11,112 / $85,000 = 13.1%. Same property, cheaper money, much better levered yield.
Rule: leverage helps when cap rate > mortgage rate. It hurts when mortgage rate > cap rate.
When to quote which
- Cap rate — comparing properties, comparing markets, comparing a property over time. Unlevered fair compare.
- Cash-on-cash — your personal decision math. "Does this property return enough on my actual invested dollars?"
- Both, always — sophisticated analysis tracks both. Cap rate tells you about the property; cash-on-cash tells you about the deal.
Cap rate + gross yield + monthly cash flow. For cash-on-cash, combine with Mortgage Calculator.