Cap Rate vs. Cash-on-Cash: How to Properly Analyze Commercial Real Estate

When analyzing commercial real estate deals, two financial metrics dominate investor conversations: Cap Rate and Cash-on-Cash Return. While both are essential tools for evaluating investment potential, they measure very different things. Misunderstanding or misapplying them can lead to poor investment decisions.

Let’s break down how each metric works—and how to use them together to make smarter commercial real estate decisions.

Here are five key reasons why:

What Is Cap Rate?

Capitalization Rate (Cap Rate) is a snapshot metric used to estimate a property’s return based on its net operating income (NOI) and purchase price.

Formula:

Cap Rate= Net Operating Income (NOI)                                                                                                                                         Purchase Price

Example:

  • NOI: $150,000
  • Purchase Price: $2,000,000
  • Cap Rate = $150,000 ÷ $2,000,000 = 7.5%

 

Cap Rate is great for:

  • Comparing properties of similar type in the same market
  • Assessing risk (lower cap rates = lower risk/return; higher cap rates = higher risk/return)
  • Evaluating deals independent of financing

 

However, cap rate ignores leverage, taxes, and loan payments. It’s a measure of unleveraged return.

What Is Cash-on-Cash Return?

Cash-on-Cash Return calculates the annual return based on the actual cash invested, factoring in debt service (mortgage payments). This makes it a more real-world profitability measure.

Formula:

Cash-on-Cash Return= Annual Pre-Tax Cash Flow                                                                                                                                        

Example:

  • NOI: $150,000
  • Annual Debt Service: $100,000
  • Pre-Tax Cash Flow: $50,000
  • Cash Invested (down payment, closing costs, CapEx): $500,000
  • Cash-on-Cash Return = $50,000 ÷ $500,000 = 10%

 

Cash-on-Cash is ideal for:

  • Evaluating how a property performs with financing
  • Determining actual return on your invested dollars
  • Measuring year-to-year investment performance

 

But: It can be skewed by leverage. A high return may come with high risk if over-leveraged.

 Cap Rate vs. Cash-on-Cash: Key Differences

 

Metric

Cap Rate

Cash-on-Cash Return

Considers Debt?

❌ No

✅ Yes

Focus

Property performance

Investor return

Use Case

Market comparison, valuation

Financing analysis, cash yield

Timing

Snapshot at purchase

Annual return, can vary over time

Risk Assessment

Indicates market/asset risk level

Indicates investor exposure to leverage

 

 

How to Use Both Together

Both metrics work best in tandem:

  • Use Cap Rate to compare market-level opportunities, understand asset risk, and spot overvalued/undervalued deals.

  • Use Cash-on-Cash to evaluate what you will earn based on your financing structure and actual capital invested.

Example Scenario:

Two properties both have a 6.5% Cap Rate, but:

  • Property A is purchased all-cash and yields a 6.5% Cash-on-Cash.

  • Property B uses 70% financing, lowering cash invested and boosting Cash-on-Cash Return to 11%—but with higher risk.

Which is better? Depends on your risk tolerance, investment strategy, and cash flow needs.

Final Thoughts

Cap Rate and Cash-on-Cash Return each tell part of the story. Cap Rate helps you understand how the property performs as an asset. Cash-on-Cash tells you how the deal performs for you as the investor.

Savvy investors analyze both to strike the right balance between risk, return, and long-term goals.

Whether you’re acquiring a 25,000 SF light industrial building or a 90,000 SF multi-tenant retail center, applying these metrics correctly can make or break your investment outcome.