BRIEFCASE GUIDES / COMMERCIAL REAL ESTATE
A cap rate tells you what a property earns relative to its price, as if you paid all cash. Cash on cash return tells you what your own invested cash earns after the mortgage payment. Cap rate describes the asset; cash on cash describes your deal.
EDUCATIONAL NOTE
This page is general information for learning purposes, not lending, tax, legal, or investment advice. Briefcase is a media and marketing company, not a lender, broker, or investment adviser. Terms, ratios, and eligibility vary by lender, sponsor, and deal, so confirm every figure with a licensed professional before you act.
01
FORMULA
Cap rate = NOI ÷ Purchase price
FORMULA
Cash on cash = (NOI − Annual debt service) ÷ Total cash invested
Both start from net operating income. The difference is the financing. The cap rate ignores the loan entirely, which makes it ideal for comparing buildings with each other. Cash on cash includes the loan payment and divides by only the cash you put in, which makes it ideal for comparing your use of money against other investments.
02
Hypothetical example: a $1,000,000 property with $60,000 of NOI (a 6% cap rate), bought with a $700,000 loan on 30-year amortization and $315,000 of total cash (down payment plus closing costs). The cap rate stays at 6% in every case. Cash on cash does not:
Loan at 5%: annual debt service
$45,093
Loan at 5%: cash flow and cash on cash
$14,907, about 4.7%
Loan at 6%: annual debt service
$50,362
Loan at 6%: cash flow and cash on cash
$9,638, about 3.1%
Loan at 7%: annual debt service
$55,885
Loan at 7%: cash flow and cash on cash
$4,115, about 1.3%
Notice that even at 5% the cash on cash return is below the 6% cap rate. That is because the loan constant (annual payment divided by loan amount, about 6.4% at a 5% rate with amortization) is already above the property's 6% yield. This is negative leverage: the more you borrow, the lower your current cash return. It is the situation many buyers have faced since mortgage rates climbed above cap rates.
03
01
Comparing properties or markets regardless of how each buyer finances them.
02
Estimating value from NOI using market cap rates from recent sales.
03
Talking with brokers, appraisers, and lenders, who all speak in cap rates.
04
Tracking how investor pricing changes over time in a market or asset class.
04
01
Deciding how much to put down and which loan to take.
02
Comparing a rental with other places your cash could go.
03
Checking whether the deal produces enough cash flow to cover surprises in year one.
04
Explaining current distributions to partners or investors.
05
Can cash on cash be higher than the cap rate? Yes, when leverage is positive: the property yield is above the loan constant, so borrowed money earns more than it costs and boosts your return on equity.
Which one do lenders care about? Lenders focus on NOI, DSCR, debt yield, and loan to value. They rarely ask about your cash on cash return, but they will use market cap rates to judge value.
Which is better for a first rental? Use both. The cap rate tells you whether the price is reasonable for the income; cash on cash tells you whether your financing leaves enough monthly cash flow to absorb surprises.
06
01
Comparing a cap rate on one deal with a cash on cash return on another. They measure different things.
02
Using a seller's pro forma NOI for the cap rate and actual costs for cash on cash.
03
Forgetting closing costs and reserves in total cash invested, which overstates cash on cash.
04
Assuming positive leverage. Check that the cap rate exceeds the loan constant before assuming debt will boost returns.
05
Ignoring appreciation and loan paydown. Neither metric captures them; IRR does.
TAKEAWAYS
01
Cap rate = NOI ÷ price, unlevered, describes the property.
02
Cash on cash = cash flow after debt ÷ cash invested, levered, describes your deal.
03
If the loan constant is above the cap rate, leverage lowers your cash on cash return.
04
Use both, plus DSCR and IRR, before committing capital.
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