Cap Rate vs Cash-on-Cash Return: A Rental Example

The same rental property can show an 8.05% cap rate and a 9.98% cash-on-cash return at the same time, because the two measures answer different questions. Cap rate divides the property's net operating income (NOI) by the purchase price and ignores how you pay for it. Cash-on-cash divides the cash left after the mortgage payment by the cash you actually put in. This article builds both from one set of numbers so you can see exactly where the gap comes from, then shows when borrowing helps the percentage and when it hurts. The figures are an example, not a forecast or a market benchmark.

Why the same property has two different return percentages

The INREV glossary, citing NCREIF, defines cap rate as NOI divided by sales price or value. Investment sponsor ArborCrowd's methodology defines cash-on-cash using annual cash flow after expenses, reserves, capital expenditure and debt service over invested cash. The comparison here states exactly which costs each numerator includes.

Build NOI from rent, vacancy and operating costs

Take a property bought for $200,000. It rents for $2,000 a month, with a 5% vacancy allowance. Yearly property tax is $3,000, insurance $1,200, maintenance $2,000 and other costs $500. There is no HOA, no management fee, no other income and no capital reserve yet.

NOI deliberately leaves out several things:

• Debt service. Both the interest and the principal on the mortgage are excluded.
• A capital reserve. In the QuantStock rental calculator a reserve sits below NOI. Other analysts put reserves inside operating expenses, so label whichever convention you use.
• Income tax and depreciation. The IRS treats depreciation, repairs and operating costs as part of its own rental tax rules, which are separate from this operating measure. For example, a security deposit you may have to return is not income. Tax depends on your situation, so this article does not model it.
• Initial repairs. This model places its initial repair budget in upfront invested cash; it is not a rule for classifying every repair expense.

Calculate purchase-price cap rate

Cap rate = NOI ÷ purchase price = $16,100 ÷ $200,000 = 8.05%.

The denominator is the purchase price, not price plus closing costs. If the property later rises in value, a cap rate on the current value would use a different denominator and give a different number, so say which one you mean. Cap rate also moves with your income assumptions. At a 10% vacancy allowance instead of 5%, NOI falls to $14,900 and the cap rate to 7.45%.

Run in reverse, a cap rate turns income into a price. Rearranging cap rate = NOI ÷ value gives value = NOI ÷ cap rate. On this NOI, a buyer who required an 8% rate would pay $201,250 ($16,100 ÷ 0.08), and one who required 7% would pay $230,000. Those prices are arithmetic on a required rate, not a market claim, and they show how sensitive value is to the rate chosen. The same logic means a cap rate is only as reliable as the NOI behind it: if rent is overstated or costs are understated, the percentage looks better than the property is.

Subtract debt service and divide by invested cash

Now add the financing. You put 20% down ($40,000) and pay $6,000 of closing costs, so your invested cash is $46,000. The $160,000 loan is at 6% for 30 years.

The monthly principal and interest payment is $959.28, which is $11,511.37 over a year. Of that, about $9,546.55 is interest and $1,964.82 is principal in the first year. Principal repayment reduces your debt and builds equity, but it is not spendable cash in your pocket, which is why cash-on-cash tracks cash flow and stays separate from equity growth.

To reconcile your own property the same way, reconcile this property's cash flow and returns in the rental property calculator, and check the loan payment itself with the mortgage calculator.

When does borrowing help the percentage? Compare the same property bought with all cash. Your cash invested would be $206,000 ($200,000 plus $6,000 closing), and the first-year return would be $16,100 ÷ $206,000 = 7.82%. The loan lifts cash-on-cash above that figure only while the mortgage's annual payment is smaller than 7.82% of the amount borrowed. At 6% that ratio is 7.19%, so leverage helps. Raise the rate and the picture changes:

At 7%, the debt payment per dollar borrowed (7.98%) is above the all-cash yield (7.82%), so the loan pulls cash-on-cash below the all-cash figure. Leverage also magnifies the downside: a thin cash flow leaves little room for a vacancy spike or a repair. Putting only 10% down instead of 20% lifts cash-on-cash to 12.11% in this example, but cuts cash flow to $3,149.71.

Add a capital reserve and see what changes

Set aside $2,000 a year for big-ticket replacements such as a roof or a water heater. In the QuantStock convention that reserve sits below NOI:

The cap rate does not move, because NOI is unchanged. Cash-on-cash drops by almost half. If you instead treated the $2,000 as an operating expense, NOI would fall to $14,100 and the cap rate to 7.05%. Neither treatment is universal, so disclose which one a percentage uses before you compare it with someone else's.

Cash-on-cash, total profit and IRR answer different questions

First-year cash-on-cash is a snapshot. It ignores growth, the eventual sale and the principal you repay. The rental calculator also shows other lenses. Using its example growth assumptions, a 20-year hold, 3% annual growth in rent and costs, 3% appreciation and 8% selling costs:

These growth rates are example inputs, not predictions. A 9.98% first-year cash-on-cash figure is not a guaranteed annual return, and it should not be compared directly with a lifetime total or with IRR. Each one needs its own assumptions stated.

Run your own numbers in the rental property calculator, and use the amortization calculator to see how much of each payment is principal over time.

Rental-return questions

Does cap rate include the mortgage?

No. In the definition used here, cap rate is NOI before debt service divided by the purchase price, so it is the same whether you borrow or pay cash. Cash-on-cash is the measure that includes financing.

Why can cash-on-cash exceed cap rate?

Financing changes both cash flow and invested cash. Here the stated numerator and denominator produce 9.98%, above the 8.05% cap rate. The earlier borrowing-cost test compares leveraged cash-on-cash with the 7.82% all-cash return, a different benchmark. Raising one does not necessarily make it exceed cap rate. Leverage can worsen losses.

Are reserve contributions an operating expense?

It depends on the convention. The calculator keeps the reserve below NOI, which leaves cap rate unchanged. Some analysts include reserves in operating expenses, which lowers NOI and cap rate. State which you used.

Is mortgage principal profit?

Not in the cash-flow sense. Principal repayment reduces your debt and builds equity, but you cannot spend it, so it is separate from operating cash flow. It counts toward your wealth when the property is sold or refinanced.

What if I invest no cash?

Then cash-on-cash is undefined, not infinite. A zero denominator means the ratio has no meaning, and the calculator shows it as undefined.

Sources

• INREV Global Definitions Database, Capitalization (Cap) Rate (source: NCREIF, dated 2 September 2025): net operating income divided by sales price or value. Accessed 27 October 2026.
• ArborCrowd, Using the Cash on Cash Return to Analyze Real Estate (27 January 2021): an investment sponsor's own calculation method; not a tax rule or an endorsement. Accessed 27 October 2026.
• Internal Revenue Service, Topic no. 414, Rental income and expenses: tax reporting context only; page last reviewed 24 September 2026. Accessed 27 October 2026.