Cap Rate vs. Cash-on-Cash Return
Cap rate vs cash on cash return explained — cap rate is the unlevered yield on price, cash-on-cash is the levered yield on the equity you actually invest.
By Michael Laudino, LFO Capital LLC · Published 2026-06-17
The cap rate is the unlevered yield on the property — NOI divided by purchase price, financing ignored. Cash-on-cash return is the levered yield on the equity you actually wrote a check for — cash flow after debt service divided by cash invested. Cap rate judges the asset; cash-on-cash judges your position in it.
The cap rate treats the deal as if you paid all cash. It strips out the loan entirely and asks one thing: at this price, what does the income stream yield? That makes it the right tool for comparing assets and judging whether you bought well, because two buyers paying the same price for the same income get the same cap rate no matter how each one finances it.
Cash-on-cash return introduces the loan. It takes the NOI, subtracts annual debt service, and divides what's left by the equity you put in — not the full purchase price. Because you're dividing a smaller numerator by a much smaller denominator, the result swings on the relationship between your loan rate and your cap rate.
When the loan rate sits below the cap rate, you have positive leverage: every borrowed dollar earns more than it costs, and the surplus accrues to your equity, pushing cash-on-cash above the cap. Flip the relationship — borrow above the cap rate — and leverage turns negative, dragging cash-on-cash below the unlevered yield. This is also why lenders watch DSCR: aggressive leverage that flatters cash-on-cash can leave too little cushion over debt service. Explore the full metric set in our metrics hub.
Worked example — positive leverage
| Line | Amount |
|---|---|
| Purchase price | $10,000,000 |
| NOI | $600,000 |
| Unlevered cap rate ($600,000 ÷ $10,000,000) | 6.00% |
| Interest-only loan ($6,500,000 at 5.5%) → annual debt service | $357,500 |
| Cash flow after debt service ($600,000 − $357,500) | $242,500 |
| Cash invested ($10,000,000 − $6,500,000) | $3,500,000 |
| Cash-on-cash ($242,500 ÷ $3,500,000) | 6.93% |
The discipline: cash-on-cash (6.93%) beats the cap (6.00%) only because the 5.5% loan rate is below the 6.0% cap — push the loan rate above the cap and leverage goes negative, dropping cash-on-cash below the cap rate.
Frequently asked questions
Why is my cash-on-cash return higher than my cap rate?
Because you have positive leverage — your loan rate is below your cap rate, so borrowed dollars earn more than they cost. The spread flows to your equity, lifting cash-on-cash above the unlevered cap. If your loan rate exceeded the cap rate, leverage would be negative and cash-on-cash would fall below it.
Does cap rate change when I use more debt?
No. Cap rate is an unlevered metric — it divides NOI by purchase price and ignores financing entirely. Adding debt changes your cash-on-cash return and your equity multiple, but the cap rate you bought at stays the same regardless of how the deal is capitalized.
Which matters more, cap rate or cash-on-cash?
They answer different questions. Cap rate tells you whether you bought the asset well relative to the market; cash-on-cash tells you what your equity earns in year one after debt service. Underwrite both — a good cap rate with negative leverage can still produce weak cash-on-cash.
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