Cap rate vs. cash-on-cash: what actually matters

New investors treat cap rate and cash-on-cash as interchangeable. They aren't — and confusing them leads to bad offers.

Cap rate measures the asset

Cap rate is NOI divided by price. It ignores financing entirely, which is exactly why it's useful: it lets you compare two buildings on equal footing regardless of how each buyer plans to finance them. It's the market's language for pricing.

Cash-on-cash measures your equity

Cash-on-cash is your annual pre-tax cash flow divided by the actual cash you put in. It's leverage-dependent — the same building can be a 4% cap and a 9% cash-on-cash return, or a negative one, depending on your loan.

Use them together

A great cap rate with thin cash-on-cash means the market is pricing in future upside you may or may not capture. A strong cash-on-cash on an aggressive loan can evaporate at refinance. Look at both, plus your exit.

• →Cap rate: are you paying a fair price relative to the market?
• →Cash-on-cash: does your equity earn a return worth the risk today?
• →DSCR: can the property carry its own debt?