Cap rate vs cash-on-cash return: a worked example with a real duplex

Cap rate and cash-on-cash return both describe how a rental performs, but they answer different questions. Cap rate asks how the property does on its own, as if you paid cash. Cash-on-cash asks what return you get on the money you actually put in, after the mortgage. Here's one duplex, a full year, both ways.

The property

Step 1: NOI (net operating income)

NOI = income − operating expenses
    = $31,275 − $6,891.55 = $24,383.45

The mortgage is not an operating expense. Neither is a new roof or any other capital improvement. Both reduce your cash, but they're financing and investment decisions, not the cost of running the property. Put them in NOI and every metric built on it is wrong.

Step 2: cap rate

Cap rate = NOI ÷ purchase price
         = $24,383.45 ÷ $310,000 = 7.9%

Cap rate is independent of how you financed the deal, so you can compare properties with it.

Step 3: cash flow and cash-on-cash

Mortgage paid (12 × $1,608.52)   = $19,302.24
Cash flow = NOI − mortgage − capital improvements
          = $24,383.45 − $19,302.24 − $0 = $5,081.21

Cash-on-cash = cash flow ÷ cash invested
             = $5,081.21 ÷ $71,500 = 7.1%

Why they differ, and what flips them

Here they're close (7.9% vs 7.1%) because the 6.75% loan costs about as much as the property earns. With a cheaper loan, cash-on-cash would beat cap rate, which is leverage working for you. In the same portfolio, a condo with $310/month HOA fees and one vacant month had a 5.8% cap rate but a −0.5% cash-on-cash: it loses money every year once the mortgage is paid, even though its cap rate looks acceptable.

Checklist

• NOI excludes the mortgage (principal and interest) and capital improvements.
• Cash invested includes closing and rehab costs, not just the down payment.
• Use a full year of actual numbers; a mid-year figure understates both.
• Count vacancy as it happened. One empty month is 8% of a year's rent.