Cap Rate vs. Cash-on-Cash Return: Which Metric Matters More for Investors?

When evaluating multifamily real estate investments, two key financial metrics often come into play: Capitalization Rate (Cap Rate) and Cash-on-Cash Return (CoC Return). While both provide insight into a property’s profitability, they serve different purposes and should be used strategically based on an investor’s goals. Understanding these metrics can help investors make more informed decisions when analyzing potential deals.

Understanding Cap Rate

Cap Rate is a measure of a property's return on investment, assuming it is purchased with cash. It helps compare properties in different markets and assess the risk and profitability of an investment.

Formula: 

When to Use Cap Rate

• Market Comparisons: Cap rate is useful for comparing similar properties in the same or different locations.

• Assessing Risk: Higher cap rates indicate higher risk but potentially higher returns, while lower cap rates suggest lower risk and steadier income.

• Valuing Properties: Investors use cap rate to estimate a property’s fair market value based on its income.

Limitations of Cap Rate

• Does not consider financing or loan structure.

• Assumes a property is purchased with cash, which is rarely the case.

• Does not account for appreciation or tax benefits.

Understanding Cash-on-Cash Return

Cash-on-Cash Return measures the actual return on the cash invested in a property. It factors in financing, making it a crucial metric for investors using leverage.

When to Use Cash-on-Cash Return

• Assessing Financing Impact: Investors who use mortgages or creative financing strategies rely on this metric to evaluate the true return on their actual investment.

• Short-Term Profitability: Useful for investors who prioritize steady cash flow over long-term appreciation.

• Evaluating Leverage Efficiency: Helps determine if leveraging a property increases profitability compared to an all-cash purchase.

Limitations of Cash-on-Cash Return

• Ignores property appreciation, depreciation benefits, and tax advantages.

• Can be misleading if cash flow fluctuates significantly year over year.

Which Metric Matters More?

The importance of Cap Rate vs. Cash-on-Cash Return depends on an investor’s strategy:

• Long-Term Investors: Cap rate is more relevant when comparing properties for long-term appreciation and market trends.

• Cash Flow Investors: CoC return is more useful for those who prioritize short-term income and financing efficiency.

• Balanced Approach: Using both metrics together provides a well-rounded view of a property’s potential performance.

Conclusion

Both Cap Rate and Cash-on-Cash Return are essential tools in multifamily real estate investing. While cap rate provides a quick market comparison, CoC return helps investors evaluate leveraged returns. Smart investors analyze both metrics to align with their investment goals and ensure profitable decision-making. Working with a trusted partner or experienced broker can help you to understand how to use various metrics to evaluate the attractiveness of a deal. We’re happy to answer any questions you may have or work with you to identify deals that meet your financial goals!