Cash-on-Cash Return vs Cap Rate: Which One Should a Small Landlord Use?

Cap rate measures the property. Cash-on-cash return measures your money. Cap rate is net operating income (NOI) divided by the price. It leaves financing out on purpose, which makes it the right tool for comparing one property with another. Cash-on-cash return is your annual pre-tax cash flow (NOI minus loan payments) divided by the total cash you put in (down payment, closing costs and upfront repairs). It includes your loan, so it answers the question "what is my cash earning this year?"

As a small landlord, you use both. Use cap rate to screen listings and check a price. Use cash-on-cash to decide whether a financed purchase is worth the cash it ties up. When the two disagree, the gap tells you whether your loan is helping or hurting.

This guide puts the two side by side and runs one hypothetical property three ways: all cash, with a cheaper loan, and with a loan that costs more than the property earns. It also covers what each number leaves out and the mistakes that make both look better than they are. For a full deal analysis with stress tests, see the rental property investment analysis guide.

The two formulas

Cap rate = NOI ÷ purchase price

Cash-on-cash return = annual pre-tax cash flow ÷ total cash invested

Where:

• NOI = gross rent − vacancy − operating expenses (taxes, insurance, maintenance, management, capital reserves, owner-paid utilities). It does not include mortgage payments.
• Annual pre-tax cash flow = NOI − annual debt service (12 monthly principal and interest payments).
• Total cash invested = down payment + closing costs + upfront repairs or rehab. The loan is not your cash, so it isn't counted.

These are the same definitions the cap rate calculator and cash-on-cash return calculator use, so you can check every number below in either tool.

Side-by-side comparison

One property, three ways to buy it

A hypothetical example: a single-family rental with these assumptions.

To keep the comparison clean, the example uses the same closing costs in every case. In practice a loan adds lender fees, which makes the financed cases slightly worse.

Step 1: NOI (the same for every buyer)

Cap rate: $15,234 ÷ $200,000 = 7.62%. That number doesn't change no matter how you pay for the property.

Step 2: Debt service

The monthly principal and interest payment on a fixed-rate loan is:

M = P × r(1 + r)^n ÷ ((1 + r)^n − 1)

where P is the loan amount, r is the annual rate ÷ 12, and n is the number of monthly payments (30 years × 12 = 360). Both financed cases borrow $150,000 ($200,000 − $50,000 down).

You can reproduce either payment, and see how it splits between principal and interest, in the mortgage amortization calculator. Taxes and insurance are already in operating expenses, so don't add an escrow payment on top.

Step 3: Cash-on-cash in each case

Three things stand out:

1. The cap rate is identical in all three columns. It describes the property, not the deal you get on it.
2. All-cash cash-on-cash (7.05%) is lower than the cap rate (7.62%). Cap rate divides by the price alone. Cash invested also includes the $16,000 of closing and rehab costs. That is one of the most common reasons your cash-on-cash comes in under the listing's cap rate, even before a loan.
3. Loan A raises your return slightly. Loan B cuts it by more than half. Same property, same NOI. The only difference is what the money costs.

Positive and negative leverage

Leverage is positive when borrowing raises your cash-on-cash return above what you'd earn paying all cash. It's negative when borrowing lowers it.

The usual shorthand is "compare the cap rate with the interest rate." Loan B fits that shorthand: its 8.0% rate is above the 7.62% cap rate, so every borrowed dollar costs more than it earns and the financed return drops to 3.07%.

The more precise test is this:

Leverage helps when the property's all-cash yield (NOI ÷ total cost, including closing and rehab) is higher than the loan constant (annual debt service ÷ loan amount).

The loan constant is higher than the interest rate because your payment also includes principal. That's why a loan can hurt even when its rate is below the cap rate. Run the same property with a hypothetical 6.5% loan: the payment is $948.10 a month, the loan constant is 7.58%, and cash-on-cash comes out at 5.84%. The rate is below the 7.62% cap rate, but the loan constant is above the 7.05% all-cash yield, so you'd earn less on your cash than if you paid all cash.

Loan A only helps a little for the same reason: its 6.81% loan constant is just under the 7.05% all-cash yield. The thinner that gap, the less a bigger loan adds, and the more a small miss in rent or expenses can flip it negative.

Negative leverage isn't automatically a reason to walk away. Some investors accept it to keep cash free for other deals, or because they expect rents to rise or plan to refinance. But you should know you're making that trade, and that you're relying on things cash-on-cash doesn't measure.

What each number ignores

Neither metric is a total return. Both are one-year, pre-tax snapshots.

Common mistakes

1. Using asking-price cap rates from listings. A listing's cap rate is the seller's number. It may use current rents below or above market, leave out management or vacancy, or use last year's taxes when a sale will trigger a reassessment. Rebuild NOI yourself, then divide by the price you would actually pay.
2. Leaving closing and rehab costs out of cash invested. Dividing by the down payment alone overstates cash-on-cash. In the Loan A case, using $50,000 instead of $66,000 would show 10.03% instead of 7.60%. If your lender gives you a Loan Estimate, its closing costs and estimated cash to close are a better starting point than a rule of thumb.
3. Using projected rents. "Rent after renovation" or the seller's pro forma is a guess. Base the analysis on rents comparable units are getting now.
4. Forgetting vacancy and capex. Both seem small in a single year. Leaving them out of this example's NOI would add $2,760 a year and push the cap rate from 7.62% to 9.0%.
5. Comparing cap rates across different markets. A cap rate is only meaningful next to recent sales of similar properties nearby. There's no single "good" cap rate: it depends on the market, the property's condition and risk, and where interest rates are.
6. Treating a high cash-on-cash as safe. A small down payment can push cash-on-cash up while making the deal fragile. Check DSCR alongside it.

A quick word on DSCR

The debt service coverage ratio (DSCR) is NOI ÷ annual debt service. It tells you how much room the income leaves over the mortgage. In the example, Loan A's 1.49 leaves a cushion. Loan B's 1.15 means a modest drop in NOI would leave little to cover the payment. Lenders that underwrite on rental income set their own minimum DSCR, so ask yours. The DSCR calculator runs it from the same inputs.

When to use which

For the refinance case, the BRRRR method guide walks through how cash left in the deal changes the math, and the BRRRR calculator runs it.

What is a good cash-on-cash return?

There isn't a universal number. A useful way to judge it is against your alternatives: what that same cash would earn with less risk and less work elsewhere, and what the property would earn if you paid all cash. If the financed cash-on-cash is lower than the all-cash yield, your loan is costing you return, as Loan B does here. If it's higher only because you put very little down, check that the DSCR still leaves room for a bad year.

Sources

Official sources cited above (checked 2026-10-27):

• University of Hawaii, Department of Mathematics: Simple Interest Amortized Loans (fixed-payment amortization formula used for the monthly payments)
• Consumer Financial Protection Bureau: Loan Estimate explainer (where lenders list rate, payment and closing costs, and estimated cash to close)