When you’re analyzing real estate deals, two metrics often come up:
- Cash on Cash Return on Investment (Cash on Cash ROI) and
- Capitalization Rate (Cap Rate)
These powerful tools can help you evaluate potential investments and make informed decisions.
They provide different perspectives on a property’s performance and can guide your investment strategy.
We’ll dive deep into Cash on Cash ROI and Cap Rate and you’ll learn:
- Key Differences – How Cash on Cash ROI and Cap Rate differ and what each tells you about an investment.
- Investor Preferences – Why some real estate investors favor one metric over the other.
- Calculation Methods – The basic formulas and a deeper look at what goes into each metric with the end goal of understanding how to improve each.
- Automated Tools – Where to find these calculations in The World’s Greatest Real Estate Deal Analysis Spreadsheet™ and the Return Quadrants™.
- Improvement Strategies – Why you might want to improve these metrics and how to do so.
Let’s get started with understanding the basics of Cash on Cash ROI and Cap Rate.
Cap Rate vs Cash on Cash ROI
When you’re analyzing real estate deals, two key metrics you’ll want to understand are Cap Rate and Cash on Cash Return on Investment.
While both provide insights into a property’s financial performance, they do so in different ways.
What Is Cap Rate?
Capitalization Rate (Cap Rate) measures how much income a property generates relative to its purchase price. The formula is simple:
Cap Rate = Net Operating Income/Purchase Price
If you’re evaluating a property you already own, you can replace the purchase price with the current value. This adjustment becomes important when using Cap Rate to estimate a property’s current market value. We’ll talk about that in just a moment.
What Is Cash on Cash ROI?
Cash on Cash Return on Investment (Cash on Cash ROI) looks at how much cash flow you’re receiving relative to the amount of cash you invested. The formula is:
Cash on Cash ROI = Cash Flow/Total Cost to Close
This calculation focuses specifically on the return generated from your actual cash investment, ignoring the property’s overall value.
What’s the Difference?
When you’re comparing Cap Rate and Cash on Cash ROI, it’s important to understand how they differ in what they measure and when to use each.
Cap Rate focuses on how much income a property generates compared to its price, without factoring in any financing. This makes it a great way to assess the property’s overall performance on its own:
- Cap Rate Ignores Financing – You’re looking at how the property performs without considering the cost of loans or mortgages.
- Who Uses It – Cap Rate is typically used by institutional investors, analysts, and those comparing properties across different markets where financing details may vary widely.
Cash on Cash ROI, on the other hand, looks at the return on the actual cash you’ve invested. It ignores the property’s overall value, focusing instead on the cash you’ve put into the deal:
- Cash on Cash ROI Ignores Property Value – It emphasizes how well your cash investment is performing, without taking into account how much the property is worth.
- Who Uses It – This metric is preferred by individual investors, especially those using leverage and prioritizing cash flow from their investments.
One key difference between the two metrics is that Net Operating Income (NOI) is not the same as Cash Flow. NOI ignores financing costs, while Cash Flow includes them. These two figures only match up if there’s no mortgage or loan on the property.
By understanding these differences, you can choose the metric that best fits your investment strategy—whether you’re more interested in the property’s performance or your return on the cash you’ve invested.
Cap Rate versus Cash On Cash ROI
When comparing Cap Rate and Cash on Cash ROI, it’s important to take a deeper look at how each metric works and when to use one over the other. Both are useful in real estate deal analysis, but they serve different purposes and provide unique insights.
Cap Rate
- Easier to Compare Properties Without Considering Financing Variables – Cap Rate lets you focus solely on the property’s income and market value, without worrying about loan terms.
- Offers a Snapshot of Performance Relative to Market Value – It shows how much income the property generates compared to its current value, giving a quick way to assess the deal.
- Helps Assess Property Risk – By focusing on income potential vs. the purchase price, Cap Rate can help you determine if the property’s income is worth the purchase price.
- Eliminates Financing Variables – Since it doesn’t account for financing, Cap Rate gives you a clear view of how the property performs on its own.
- Useful for Long-Term Holding and Market Comparisons – It’s often used by investors with long-term strategies or those comparing properties in different markets.
- Ideal for Income Potential – Investors who care more about the property’s income than how it’s financed tend to prefer Cap Rate.
- Ignores Financing Impact – This can be helpful or problematic, depending on your financing strategy. If loans are central to your investment, this metric may not tell the full story.
- Varies Widely by Market – Cap Rates can fluctuate greatly between markets, making it less reliable without a deep understanding of local market conditions.
- Can Be Misleading – If you don’t consider factors like property condition or location, Cap Rate may not paint an accurate picture of the deal’s potential.
Cash on Cash ROI
- Straightforward Understanding of Cash Returns – Cash on Cash ROI gives a clear picture of what you’re earning on the cash you’ve put into the deal.
- Focuses on Actual Cash Return – It considers leverage, showing how well your cash investment is performing, which is crucial for leveraged investors who get loans to buy properties.
- Reflects Investor Risk – By highlighting the actual return on cash invested, it helps measure risk, especially for those using financing.
- Shows Financing Impact – Since Cash on Cash ROI factors in the cost of financing, it provides a more complete view of how well your investment is working for you.
- Useful for Short-Term Cash Flow Strategies – Investors who prioritize cash flow and short-term returns will find this metric valuable.
- Ideal for Financing Strategies – Those focused on maximizing returns through smart financing will rely more on Cash on Cash ROI.
- Can Be Misleading – If you have bad loan terms (like a temporary low rate) or upcoming expensive capital expenses/maintenance due not reflected in your calculation, Cash on Cash ROI can give a false sense of success.
- Focuses Solely on Cash Investment – While useful, it doesn’t account for other financial factors like appreciation, debt paydown, or tax benefits.
- Can Overemphasize Short-Term Gains – By focusing on immediate returns, it may overlook the long-term returns you see from these other areas we just mentioned (appreciation, debt paydown or tax benefits).
Cap Rate on Multi-Family
Cap Rate is especially useful when analyzing multi-family properties. It gives you a simple way to compare properties of different sizes and prices, helping you decide which one might be the better investment.
For example, you can look at a 14-unit property selling for $1.4 million and compare it to a 27-unit property selling for $2.8 million. Even though they’re different in size and price, Cap Rate allows you to assess which one generates more income relative to its price.
This makes it easier to compare properties across the market and make decisions based on income potential, not just price or size. Investors in multi-family properties often rely on Cap Rate to quickly evaluate deals like this.
If you know the Cap Rate for similar properties in the same area, you can use it to determine a property’s value based on its income. This gives you a tool for understanding whether a property is priced appropriately for its income level.
Property Value from Cap Rate
If you know a property’s Net Operating Income (NOI) and the typical Cap Rates for similar properties in your market, you can estimate the property’s value using a simple formula. Cap Rate is calculated like this:
Cap Rate = Net Operating Income/Purchase Price
To determine the property’s value, you can re-arrange the formula:
Property Value = Net Operating Income/Cap Rate
Start by calculating the NOI for the property, which is the income generated after deducting operating expenses. Then, find the prevailing Cap Rates for similar properties in your market. These Cap Rates are typically based on recent sales of comparable properties, so it’s important to use accurate and up-to-date information.
Once you have both the NOI and the Cap Rate, you can plug those numbers into the formula to estimate the property’s value. This approach works best when the properties you’re comparing are similar in terms of location, size, and condition, so make sure the Cap Rates you’re using are from properties that closely match the one you’re analyzing.
By using this method, you can quickly assess whether a property is priced fairly based on the income it produces.
Calculated For You
Both Cap Rate and Cash on Cash Return on Investment are automatically calculated for you in The World’s Greatest Real Estate Deal Analysis Spreadsheet™.
This makes it easy to see how your property performs over time without manually doing the math.
On the main Dashboard tab, you’ll find a chart that provides a summary of the first five years of Cap Rate and Cash on Cash ROI.
The chart gives you a quick snapshot of how both these metrics evolve in the early years of your investment.
Every Year in Overrides
In addition to the first five years, The World’s Greatest Real Estate Deal Analysis Spreadsheet™ also tracks Cap Rate and Cash on Cash ROI for every year of your investment. You can find these calculations on the Overrides tab.
This feature allows you to see how both Cap Rate and Cash on Cash ROI change each year as you hold the property.
It’s especially useful because the numbers update automatically as you adjust the spreadsheet for changes in income, expenses, or other variables over your ownership period—not just when you’re first buying the property. This gives you an ongoing view of your investment’s performance year by year.
Deeper Dive in Calculations
You might already know that Cap Rate is calculated by dividing Net Operating Income (NOI) by Purchase Price, and Cash on Cash ROI is calculated by dividing Cash Flow by Total Invested.
But let’s break down what really impacts those numbers, so you can get a better understanding of what drives both Cap Rate and Cash on Cash ROI.
Visual Cap Rate Calculator for Rental Property™
When calculating Cap Rate, it’s helpful to understand each component that goes into the formula and how these numbers reflect the property’s performance.
The Visual Cap Rate Calculator for Rental Property™ breaks down each step, giving you a clear view of how to reach the final Cap Rate.
Let’s walk through the process step-by-step, explaining what each input means and how it affects the Cap Rate calculation.
Then, we’ll look at how to improve inputs to ultimately improve your Cap Rate.
Step 1: Gross Potential Income
Gross Potential Income = Rent + Other Income
Gross Potential Income is the total amount of income the property could generate if it were fully rented out and collecting all potential income streams. This includes:
- Rent – The total annual rent collected from tenants.
- Other Income – Additional sources of income like parking fees, laundry facilities, or storage rentals.
Gross Potential Income assumes the property is 100% occupied and collecting rent from every unit, without any vacancies or missed payments.
Step 2: Gross Operating Income
Gross Operating Income = Gross Potential Income - Vacancy Loss
Gross Operating Income takes into account potential losses from vacancies.
You subtract the vacancy loss, which represents the income you expect to lose because not all units will be occupied 100% of the time.
- Vacancy Loss – The income lost due to units being vacant or renters not paying. This is typically calculated as a percentage of Gross Potential Income based on average vacancy rates in your market.
By subtracting the vacancy loss, you get the actual income the property is likely to generate after accounting for periods without tenants.
Step 3: Operating Expenses
Operating Expenses = Sum of All Costs to Run the Property (excluding mortgage payments)
Operating Expenses are the costs of running the property. These expenses do not include any financing costs like mortgage payments but do include:
- Property Taxes – Annual taxes paid to the local government.
- Property Insurance – The cost of insuring the property against risks like fire or liability.
- HOA Fees – Any homeowner’s association fees, if applicable.
- Landlord-Paid Utilities – Any utilities the landlord is responsible for, such as water, gas, or electricity. This is less common with single-family homes, condos, and townhomes but more common with multi-family properties. The larger the property, the more likely the landlord will have some landlord-paid utilities (especially for common areas), such as in a 10-unit property compared to a duplex.
- Other Expenses – Any other costs associated with operating the property including advertising, legal fees, etc.
- Maintenance – The cost of repairs, upkeep, and regular maintenance to keep the property in good condition.
- Property Management Fees – If you hire a property manager to oversee the property, this will be a regular expense.
These, along with any other regular costs associated with operating the property, make up the total Operating Expenses.
Step 4: Net Operating Income (NOI)
Net Operating Income = Gross Operating Income - Operating Expenses
Net Operating Income (NOI) is the income the property generates after paying for all operating expenses. It is a key figure in the Cap Rate calculation because it shows how much income the property brings in without considering the cost of financing.
And, now you can also see what goes into calculating the NOI. That’s the first step toward being able to improve NOI to ultimately improve the Cap Rate.
Step 5: Purchase Price or Property Value
Cap Rate = Net Operating Income / Purchase Price
Purchase Price or Property Value is the amount you paid to buy the property or the current market value of the property. Cap Rate compares the income generated by the property (NOI) to its value.
In some cases, you may use the purchase price (if recently bought) or the current market value (if you’re evaluating a property already owned).
Step 6: Calculating the Cap Rate
Cap Rate = Net Operating Income / Purchase Price
Cap Rate is calculated by dividing the Net Operating Income by the Purchase Price or Property Value. The result is expressed as a percentage and represents the rate of return based on the property’s income, independent of financing.
By breaking down each step and input, you can better understand how Cap Rate is calculated and what factors influence it.
After we walk through the same exercise for Cash on Cash Return on Investment, we will look at methodically improving each input for both Cap Rate and Cash on Cash Return on Investment and how that affects the returns we see.
Visual Cash on Cash Return on Investment Calculator for Rental Property™
Let’s walk through the calculation of Cash on Cash Return on Investment step-by-step, using the Visual Cash on Cash Return on Investment Calculator for Rental Property™ as a guide.
Just like we did with Cap Rate, we’ll break down each input and explain what it represents in the overall calculation.
In fact, calculating Net Operating Income will be identical to what we went over for Cap Rate.
Step 1: Gross Potential Income
Formula: Gross Potential Income = Rent + Other Income
Gross Potential Income is the total income the property could generate if it’s fully occupied and collecting all potential income sources. This includes:
- Rent – The total annual rent collected from tenants.
- Other Income – Additional sources of income, such as parking fees, laundry services, or other amenities offered at the property.
This step gives you the maximum potential income if everything goes perfectly, assuming no vacancies or payment issues.
Step 2: Gross Operating Income
Gross Operating Income = Gross Potential Income - Vacancy Loss
To calculate the Gross Operating Income, we account for the fact that no property stays fully occupied all the time. This step subtracts potential losses from vacancies:
- Vacancy Loss – This is an estimate of the income lost due to units being vacant during the year. It’s typically calculated as a percentage of Gross Potential Income based on market averages.
By subtracting the Vacancy Loss, you get the Gross Operating Income, which reflects a more realistic expectation of how much rent you’ll collect.
Step 3: Operating Expenses
Operating Expenses = Sum of All Costs to Run the Property (excluding mortgage payments)
Operating Expenses are the costs associated with running the property. They do not include mortgage payments but do include:
- Property Taxes – Recurring charges levied by local authorities on the property’s assessed value.
- Property Insurance – Premiums paid to protect against potential property damage and liability claims.
- HOA Fees – Regular contributions to homeowners’ associations for shared amenities and services, if applicable.
- Landlord-Paid Utilities – Costs for utilities covered by the property owner, more prevalent in larger multi-family properties and common areas.
- Other Expenses – Various operational costs including marketing, legal services, and administrative fees.
- Maintenance and Repairs – Ongoing expenditures for property upkeep, preventative maintenance, and necessary repairs.
- Property Management – Fees paid to professional managers for overseeing property operations and tenant relations.
Adding up all these expenses gives you the total Operating Expenses for the property.
Step 4: Net Operating Income (NOI)
Net Operating Income = Gross Operating Income - Operating Expenses
Net Operating Income (NOI) represents the income the property generates after covering all Operating Expenses but before mortgage payments.
But what about those mortgage payments?
Step 5: Cash Flow
Formula: Cash Flow = Net Operating Income – Mortgage Payments – Private Mortgage Insurance
Once you have the NOI, you subtract your mortgage payments to get the property’s Cash Flow.
This step reflects the actual cash left over after paying for all expenses, including financing.
- Mortgage Payments – These are the annual payments made toward the property’s mortgage, including both principal and interest.
- Private Mortgage Insurance (PMI)– An additional fee charged by lenders when a borrower’s down payment is less than 20% of the property’s value. PMI protects the lender in case of default.
The result is your Cash Flow, which tells you how much money you’re actually pocketing from the property after all expenses and debt service.
Step 6: Total Cost to Close
Total Cost to Close = Down Payment + Closing Costs + Rent Ready Costs - Seller Concessions + Cumulative Negative Cash Flow
Total Cost to Close represents the total amount of cash you’ve invested to acquire the property. It includes:
- Down Payment – The amount of cash you’ve put down to purchase the property, usually a percentage of the purchase price.
- Closing Costs – Fees and expenses related to the transaction, including appraisal fees, title insurance, and loan origination fees.
- Rent Ready Costs – Expenses incurred to prepare a property for rental, such as cleaning, repairs, or upgrades needed before tenants can move in.
- Seller Concessions – Contributions from the seller to help cover the buyer’s closing costs or other expenses, effectively reducing the total out-of-pocket cost for the buyer.
- Cumulative Negative Cash Flow – The total amount of negative cash flow, if any, before rents creep up enough so that you no longer have negative cash flow on the property.
This figure is important because it reflects your total cash investment in the deal.
Step 7: Calculating Cash on Cash Return on Investment
Cash on Cash ROI = Cash Flow / Total Cost to Close
The final step is to calculate Cash on Cash Return on Investment by dividing the Cash Flow by your Total Cost to Close.
This gives you a percentage that represents how much return you’re getting based on the cash you’ve invested.
Remember, Cash on Cash ROI focuses on how well your cash investment (Total Cost to Close here) is performing.
By understanding each input, you can see how changes in any of these factors—like higher rent, lower expenses, or lower closing costs—can impact your Cash on Cash ROI. This makes it a useful tool for evaluating the cash performance of a rental property.
We will get to that in a moment for both Cash on Cash Return on Investment and Cap Rate.
Return on Investment Quadrant™
In the Return Quadrants™, Cap Rate and Cash on Cash Return on Investment play important roles, but they fit into the framework in very different ways.
First, let’s talk about the Return on Investment Quadrant™.
The Cash Flow part of the Return on Investment Quadrants™ is basically represented by Cash on Cash ROI. This is because we’re looking at the Cash Flow the property produces, divided by the Total Investment. The total investment is the actual cash you’ve put into the property, such as the down payment, closing costs, rent ready costs, cumulative negative cash flow (if applicable) and reserves.
On the other hand, Cap Rate doesn’t typically appear directly in the Return on Investment Quadrants™ because it doesn’t factor in financing.
Cap Rate focuses on the property’s income relative to its purchase price, independent of how much cash you’ve invested.
However, when a property is paid off, the Return on Equity Quadrant™ becomes more like Cap Rate. We’ve switched from talking about Return on Investment Quadrant™ to Return on Equity Quadrant™.
At that point:
- Your equity in the property is the property value because it is paid off and there’s no more loan.
- And, you no longer have a loan so Net Operating Income (NOI) is cash flow.
Well, that’s looking just like Cap Rate with NOI and Property Value.
This shift means that, with no debt, the property’s returns resemble a Cap Rate calculation since both Cash Flow and NOI align, and your equity equals the property’s full value.
This isn’t entirely accurate, as the Return Quadrants™ typically include reserves and cumulative negative cash flow. While I believe this approach is more comprehensive, these factors are not usually part of traditional Cash on Cash Return on Investment or Cap Rate calculations.
Basically—ignoring the technical differences with reserves and cumulative negative cash flow—for the Return Quadrants™:
- Cash on Cash Return on Investment is the Cash Flow quadrant of the Return on Investment Quadrant™, and
- Cap Rate is basically the Cash Flow quadrant of the Return on Equity Quadrant™ when you’ve paid off the property and it no longer has a loan.
Improving Cap Rate
Improving the Cap Rate of an investment property can significantly increase its value, especially for multi-family properties where income approaches are often used for valuation.
Unlike single-family homes, condos, townhomes, duplexes, triplexes, and fourplexes, which are typically valued using the comparable sales approach, multi-family properties are valued based on the income they generate.
So, by improving the Cap Rate, you’re effectively increasing the value of the property.
How Do You Improve Cap Rate?
Improving Cap Rate comes down to three key strategies:
- Increase Income – By raising rent or adding additional sources of income (like parking fees or laundry), you increase the property’s Gross Potential Income, which in turn boosts Cap Rate.
- Reduce Expenses – Lowering operating expenses like property taxes, insurance, and maintenance costs can also improve Cap Rate, as it increases your Net Operating Income (NOI). Note that financing costs like mortgage payments do not affect Cap Rate calculations.
- Lower Purchase Price (Value) – If you can negotiate a lower purchase price or wait for the property’s value to drop, the Cap Rate will increase, assuming the NOI stays the same.
An Example Improving Inputs by 10%
Let’s walk through an example using the Improve Cap Rate Focuser™ where we adjust each input by 10% to see how it impacts Cap Rate.
Remember, these are just examples—every property will be different. You’ll need to analyze your own investments, but you can see how focusing on certain inputs can have a disproportionate impact on Cap Rate improvements.
- Rent and Other Income – Increasing rent and other income by 10% has a noticeable impact on Cap Rate. In this case, it raises the new Cap Rate to 5.571%, a 13.39% improvement over the original.
- Vacancy – Reducing vacancy by 10% has a smaller impact on Cap Rate, raising it to 4.933%. That’s only a 0.40% improvement, but still a step in the right direction.
- Gross Operating Income – A 10% increase in Gross Operating Income leads to a Cap Rate of 5.567%, which represents a 13.31% improvement.
- Operating Expenses – Reducing Property Taxes, Insurance, Maintenance, or other expenses by 10% helps, but each has a relatively small impact. For example:
- Property Taxes decrease raises Cap Rate to 4.978%, a 1.32% improvement.
- Property Insurance reduction improves Cap Rate by 0.65%.
- Maintenance reductions give a 1.34% improvement.
- Purchase Price – A 10% reduction in the purchase price increases Cap Rate to 5.459%, improving it by 11.11%.
What Makes the Biggest Difference?
In this example, increasing rent or income and lowering the purchase price have the biggest impact on improving Cap Rate.
Lowering operating expenses helps, but the effect is more gradual compared to increasing income or lowering the price. Each property is different, though, so it’s important to do this kind of analysis on your specific deal.
The Improve Cap Rate Focuser™ highlights how changes in different inputs can affect the Cap Rate, and it’s a good exercise to adjust these values for your own property to see where improvements can make the most difference.
For a deeper dive into strategies to increase cash flow and lower expenses, see our material on improving cash flow.
Improving Cash on Cash ROI
Improving Cash on Cash Return on Investment (ROI) is a key focus for many real estate investors. By maximizing the Cash Flow return, you’re able to make your investments more efficient and move closer to your financial goals.
Why Focus on Maximizing Cash Flow?
Focusing on Cash Flow offers several advantages:
- Reduces Risk – More cash flow means more cushion in case something goes wrong, like unexpected expenses or vacancy.
- Financial Independence – If your goal is to achieve financial independence through real estate, increasing your cash flow brings you closer to covering your expenses.
- Faster Savings for Additional Investments – More cash flow allows you to reinvest sooner, which can speed up your path to acquiring additional properties and growing your portfolio.
- Improves Loan Qualification – Higher cash flow improves your Debt-To-Income (DTI) ratio and Debt Service Coverage Ratio (DSCR), making it easier to qualify for better loans.
How Do You Improve Cash on Cash ROI?
Improving Cash on Cash ROI can be done through several strategies:
- Increase Income – Raising rents or adding additional income streams (like pet fees, parking, or storage) increases the total cash you collect, improving Cash Flow.
- Reduce Expenses – Lowering operating expenses like property taxes, insurance, or maintenance costs directly boosts your Cash Flow, improving ROI.
- Improve Financing – Refinancing or negotiating better loan terms (lower interest rates or longer terms) can reduce your mortgage payments and increase Cash Flow.
- Reduce the Amount You’ve Invested – Finding ways to lower your total upfront investment (e.g., negotiating for lower closing costs or using less cash for repairs) can also improve Cash on Cash ROI.
An Example Improving Inputs by 10%
Let’s use the Improve Cash on Cash Return on Investment Focuser™ to see how adjusting various inputs by 10% impacts Cash on Cash ROI.
Again, these are just examples, and the results will vary based on your property.
- Rent and Other Income – A 10% increase in rent and other income has the most significant impact, raising Cash on Cash ROI from 4.895% to 7.730%, a 57.92% improvement.
- Vacancy – Reducing vacancy by 10% provides a smaller improvement, raising the ROI to 4.980%, a 1.74% increase.
- Operating Expenses – Reducing expenses like property taxes or insurance by 10% improves Cash on Cash ROI, but the impact is smaller:
- Property taxes reduction improves ROI by 5.72%.
- Property insurance reduction increases ROI by 2.82%.
- Maintenance reduction raises ROI by 5.79%.
- Mortgage Payments – Reducing mortgage payments by 10% has a significant effect, improving ROI to 6.522%, a 33.25% increase.
- Total Cost to Close – Reducing your total upfront investment (closing costs, down payment, etc.) by 10% improves Cash on Cash ROI to 5.439%, an 11.11% improvement.
What Makes the Biggest Difference?
From this example, we can see that increasing rent or reducing the mortgage payments has the most substantial impact on improving Cash on Cash ROI. Lowering operating expenses and reducing your upfront investment also help, but the gains are smaller compared to increasing income or improving loan terms.
The Improve Cash on Cash ROI Focuser™ provides a great way to see how changes to different inputs affect your investment. You can use this tool to adjust values for your own property and focus on the areas that will make the most impact on your ROI.
See 88 Ways to Improve Cash Flow from Real Estate Rental Properties for more information.