Analyze cash flow, cap rate, cash-on-cash return, and long-term equity for rental property investments.
Cap rate and cash-on-cash return look like cousins and listings quote them interchangeably, but they answer different questions. Cap rate divides net operating income by the purchase price and ignores the mortgage entirely. Cash-on-cash divides the year's cash flow after the mortgage by the cash you put down. On the default property below the cap rate is a positive 5.29% while cash-on-cash is −2.79%, and both numbers are correct.
The default deal is a $300,000 property with 25% down ($75,000) and a $225,000 loan at 7% over 30 years, renting for $2,200 a month. A 5% vacancy rate leaves effective rent of $2,200 × 0.95 = $2,090.
Operating expenses are property tax ($300,000 × 1.2% ÷ 12 = $300.00), insurance $100, repairs $150, other $50, utilities $0, and a management fee charged on collected rent (8% × $2,090 = $167.20). They total $767.20 a month.
NOI = effective rent − operating expenses = $2,090 − $767.20 = $1,322.80 a month, or $15,873.60 a year. Cap rate = annual NOI ÷ price = $15,873.60 ÷ $300,000 = 5.29%. Neither figure touches the loan.
Now add the mortgage. The payment on $225,000 at 7% over 360 months is $1,496.93, so monthly cash flow = $1,322.80 − $1,496.93 = −$174.13, or −$2,089.57 a year. Cash-on-cash = annual cash flow ÷ down payment = −$2,089.57 ÷ $75,000 = −2.79%.
The projection grows the price monthly at the appreciation rate. At 3% a year for 10 years the property is worth $404,806, and the loan balance after 120 payments is $193,078, leaving equity of $211,728. Total return = (equity − down payment + cumulative cash flow) ÷ down payment = ($211,728 − $75,000 − $20,896) ÷ $75,000 = 154.4%. That is a ten-year total, not a yearly rate, and it ignores selling costs and taxes.
Because cap rate excludes financing by design. At 6% instead of 7% the default deal still shows 5.29%, but monthly cash flow improves to −$26.19 and cash-on-cash moves to −0.42%.
At 10% vacancy, NOI falls to $1,221.60 a month, the cap rate to 4.89% and monthly cash flow to −$275.33. Vacancy also shrinks the management fee here, because the fee is charged on collected rent.
No. The denominator is only price × down payment percent. Closing costs, rehab and reserves are not inputs, so the true ratio is lower than shown. Add those costs to the down payment yourself and divide the annual cash flow by the larger total.
No, it is a ten-year total. Compounded, 154.4% over ten years is roughly 9.8% a year, though that treats cash flow as if it arrived at the end. Selling costs and taxes would lower it.
Large one-off repairs such as a roof, HOA dues, income tax, depreciation, loan closing costs and mortgage insurance. With 25% down no PMI is needed, but at lower down payments add it through the Other field.
There is no universal answer, but compare it to the loan rate. When the cap rate (5.29%) sits below the interest rate (7%), every borrowed dollar costs more than the property earns on it, so debt pulls your return on cash down instead of lifting it, and that shows up here as negative cash flow.