Real Estate Tax Calc
Cap rate
Cap rate = net operating income ÷ property price. It ignores financing, so it measures the property's unleveraged yield — useful for comparing properties regardless of how they're paid for.
Cash-on-cash return
Cash-on-cash = annual pre-tax cash flow ÷ cash invested. It includes your mortgage and down payment, so it measures how hard your actual out-of-pocket dollars work.
Which to use
Use cap rate to compare deals apples-to-apples; use cash-on-cash to judge your real return given your financing. Leverage can make a modest cap rate into a strong cash-on-cash return — or amplify losses.
The formulas, precisely
The two metrics share a numerator's cousin but differ in what they divide by and what they count. Cap rate = net operating income ÷ property price, where NOI is rental income minus all operating expenses but before any mortgage payment. Cash-on-cash = annual pre-tax cash flow ÷ total cash invested, where cash flow is NOI minus the full debt service, and cash invested is your down payment plus closing costs and rehab — not the whole price. The crucial structural difference: cap rate deliberately strips out financing to isolate the property, while cash-on-cash deliberately includes it to measure your personal, leveraged return. Neither is 'more correct' — they are built to answer different questions, and using the wrong one for the job produces misleading conclusions.
A worked example showing the gap
Take a $300,000 property with $18,000 of NOI. Its cap rate is 6% ($18,000 ÷ $300,000) — that is the property's yield regardless of how you pay for it. Now finance it: put $75,000 down (plus $9,000 in costs and rehab, so $84,000 invested) and borrow $225,000 at 7%, costing about $17,950/year in payments. Cash flow is $18,000 − $17,950 ≈ $50... a near-zero cash-on-cash, because at these rates the loan nearly consumes the NOI. Change the loan to 5% and the payment falls to about $14,500, lifting cash flow to $3,500 and cash-on-cash to roughly 4.2%. Same 6% cap rate, wildly different cash-on-cash depending purely on the interest rate. This is the heart of it: cap rate is fixed by the property; cash-on-cash moves with your financing.
Cap rate's real job: valuation and comparison
Cap rate is fundamentally a pricing tool, not just a return metric. Because it ignores financing, it lets you compare two buildings on equal footing and back into what a property is worth: value = NOI ÷ market cap rate. If similar buildings in an area trade at a 6% cap and a property produces $30,000 of NOI, its implied value is about $500,000. Investors and appraisers use prevailing cap rates to judge whether an asking price is reasonable and to estimate value after they raise rents or cut expenses (which lifts NOI and, at a constant cap rate, the property's worth). Cash-on-cash cannot do any of this — it is personal to your loan and down payment, so it says nothing about what the property is worth to anyone else.
Cash-on-cash's real job: judging your actual return
Where cap rate values the asset, cash-on-cash tells you how hard your specific dollars are working after your specific financing. Two investors buying the identical building at the same price will share a cap rate but can have very different cash-on-cash returns depending on how much they put down and what rate they got. That makes cash-on-cash the right tool for a personal decision: given the loan I can actually get and the cash I must actually commit, what current yield do I earn? It is the number that tells you whether a deal will feed you cash or drain it each month — which cap rate, blind to your mortgage, simply cannot answer.
The spread between them reveals your leverage
Comparing the two numbers is itself informative. When your cash-on-cash is higher than the cap rate, you have positive leverage — your borrowing cost is below the property's yield, so debt is amplifying your return. When cash-on-cash is lower than the cap rate, you have negative leverage — the loan costs more than the property yields, so financing is dragging your return down (the near-zero example above is negative leverage). Watching the gap between cap rate and cash-on-cash is a quick way to see whether the debt you are taking on is helping or hurting. In low-rate environments the two often diverge favorably; in high-rate environments cash-on-cash frequently falls below the cap rate at market prices.
Where neither metric is enough
Both are single-year snapshots that ignore the future. Cap rate and cash-on-cash both miss appreciation, principal paydown, rent growth, and the eventual tax at sale — including depreciation recapture (up to 25%) and capital gains. A property can have a mediocre cap rate and thin cash-on-cash yet be an excellent long-term investment because of location-driven appreciation and the tenant steadily retiring your loan. For the full picture you need a multi-year projection and metrics like IRR and the equity multiple, which account for timing and the exit. Use cap rate to price and screen, cash-on-cash to judge your current financed yield, and IRR to compare whole-hold outcomes — no single number should drive a purchase.
What moving cap rates signal
Because cap rate and price move inversely at a given NOI, prevailing cap rates tell a story about the market. Falling (compressing) cap rates mean buyers are paying more per dollar of NOI — often driven by cheap financing, optimism, or competition — which lifts values but thins yields. Rising (expanding) cap rates mean the opposite: prices soften relative to income, usually alongside higher interest rates or cooling demand, which hurts current owners' values but improves yields for new buyers. Watching where cap rates sit in your market, and which way they are trending, helps you judge whether you are buying near a peak or a trough. It also warns of cap-rate risk at your own exit: if you buy at a 5% cap and market caps drift to 6.5% by the time you sell, your sale price falls even if you grew the NOI.
Common cap rate mistakes
Cap rate is simple to state and easy to misuse. The most common error is using a seller's pro-forma NOI — built on optimistic rents and understated expenses — instead of the property's actual, trailing numbers; a rosy NOI produces a flattering cap rate on the same price. Others forget to include a management expense even when they will self-manage (your time has value), omit vacancy and reserves from NOI, or mistakenly subtract the mortgage from NOI (debt service does not belong in a cap rate — that would turn it into a cash-flow metric). Also beware comparing cap rates across dissimilar markets or property types as if they were interchangeable; a 5% cap in a prime metro and an 8% cap in a rural area reflect very different risk, not simply different quality. Verify the NOI before you trust the cap rate.
The debt yield: what lenders watch
Investors track cap rate and cash-on-cash; lenders increasingly watch a third ratio, the debt yield (NOI ÷ loan amount). Unlike the debt-service coverage ratio, debt yield ignores the interest rate and amortization entirely, giving the lender a clean read on how much income secures each dollar lent — a measure that does not flatter a loan just because rates are low. Many commercial lenders want a debt yield of roughly 8–10% or higher. Knowing this metric helps you anticipate how much a lender will actually advance: if the debt yield floor caps the loan below what the purchase price and cap rate would otherwise support, you will need more equity, which in turn lowers your cash-on-cash. Cap rate values the asset, cash-on-cash measures your return, and debt yield governs how much leverage the lender will let you use — all three interact to shape a real deal.
A quick guide to which one to reach for
When you are staring at a listing, a simple rule of thumb tells you which metric to grab. Reaching a view on price or comparing properties regardless of financing? Use the cap rate — it strips out your loan and lets you value the asset and stack it against comparable buildings. Deciding whether your specific purchase, with your down payment and your mortgage, will put cash in your pocket each month? Use cash-on-cash — it counts your actual dollars and your actual debt. Weighing deals with different hold periods or an eventual sale? Move to IRR and the equity multiple, which capture timing and the exit. In practice you compute cap rate and cash-on-cash together on every deal — cap rate to judge the price, cash-on-cash to judge your return — and only build the fuller IRR model for the finalists. Using the right tool for each question keeps you from drawing pricing conclusions from a financing metric, or vice versa.
Frequently asked questions
What's the difference between cap rate and cash-on-cash?
Cap rate ignores financing (NOI ÷ price, an unleveraged yield); cash-on-cash includes your loan and down payment (cash flow after debt service ÷ cash invested, a leveraged return on your money).
Which is better?
Neither — they answer different questions. Use cap rate to compare properties, cash-on-cash to judge your financed return.
Can cap rate and cash-on-cash be very different on the same property?
Yes. They share the same NOI foundation but diverge based on your financing. A 6% cap-rate property can show a cash-on-cash anywhere from negative to well above 6% depending on your down payment and interest rate.
How do I use cap rate to value a property?
Divide the property's net operating income by the prevailing market cap rate for similar buildings: value = NOI ÷ cap rate. Raising NOI (higher rents or lower expenses) increases the implied value at a constant cap rate.
What does it mean when cash-on-cash is higher than the cap rate?
It means you have positive leverage — your mortgage rate is below the property's yield, so borrowing amplifies your return. When cash-on-cash falls below the cap rate, the loan costs more than the property yields (negative leverage) and debt is dragging your return down.
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.