Cap rate vs cash-on-cash return vs NOI for a small apartment building
NOI is the building's yearly income after operating expenses, before loan payments. Cap rate is NOI divided by the price, so it compares buildings regardless of financing. Cash-on-cash return is the yearly cash left after loan payments divided by the cash you put in, so it shows what your money earns with your loan. All three use the same NOI, so get that right first.
The three numbers in one line each
| Number | Formula | Answers |
|---|---|---|
| NOI | Rent and other income minus operating expenses | How much does the building earn? |
| Cap rate | NOI divided by price (or value) | How does this building compare to others? |
| Cash-on-cash return | Yearly cash flow after loan payments divided by cash invested | How hard is my cash working? |
For how to build NOI line by line, see how to calculate NOI for an apartment building. It leaves out the mortgage, depreciation and income taxes. That is the reason NOI and cap rate describe the building and not you.
One building, run through all three
Example a made-up 16 unit building is for sale at $1,200,000. Its NOI, built from a real rent roll and a full year of expenses, is $96,000. The buyer puts 25% down ($300,000) and pays $24,000 in closing costs, and borrows $900,000. The loan payments (principal and interest) are $72,000 a year.
| Step | Math | Result |
|---|---|---|
| Cap rate | $96,000 / $1,200,000 | 8.0% |
| Cash invested | $300,000 + $24,000 | $324,000 |
| Cash flow after loan payments | $96,000 - $72,000 | $24,000 |
| Cash-on-cash return | $24,000 / $324,000 | 7.4% |
The cap rate would be 8.0% whether the buyer paid cash or borrowed. The cash-on-cash return changed because of the loan. That is the whole difference between the two.
What cap rate is good for
Cap rate lets you compare two buildings on price versus income without arguing about loans. If building A is priced at an 8.0% cap and building B at 6.5%, you are paying more per dollar of NOI for B. It does not say which is the better purchase, because the reasons for a lower cap, such as a stronger area or newer systems, may be real. You can also work it backward: NOI divided by the cap rate buyers are paying nearby gives a rough value.
Example if comparable buildings nearby trade at an 8.0% cap and your made-up building has $96,000 of NOI, $96,000 / 0.08 = $1,200,000. Raising NOI by $5,000 at the same cap rate adds $5,000 / 0.08 = $62,500 of value.
That last line is why owners care about expenses and rent: a dollar of NOI is worth many dollars of value. It also means a seller's pro forma NOI deserves a hard look. Use the last 12 months of real rent and real bills, not projected rent and trimmed expenses.
A quick test when a listing quotes a cap rate: ask what NOI it used. Ask whether property taxes are reset for the new price, whether insurance is the current quote, whether management and a vacancy allowance are included, and whether repairs and turnover are at a realistic level. Two buildings with the same advertised cap rate can differ by several points once you rebuild NOI the same way for both.
What cash-on-cash return is good for
Cash-on-cash measures the first-year (or any year's) cash yield on the money you actually invested, including closing costs and any money put in for repairs. It changes with the loan: a higher interest rate lowers it, a bigger down payment raises or lowers it depending on the loan cost. It leaves out principal paydown, appreciation and tax benefits, so it understates the full picture and it is not a total return.
Example take the same building, but the buyer sets aside $8,000 a year for big repairs such as roofs and boilers. Cash flow becomes $24,000 - $8,000 = $16,000, and the cash-on-cash return is $16,000 / $324,000 = 4.9%. NOI did not change, but the number that matters to the owner's pocket did.
The loan payment in this math is principal plus interest. For books, only the interest is an expense; see how to record a mortgage payment. For the cash-on-cash calculation, however, principal is real cash leaving your account, so use the whole payment.
Common mistakes
- Using the mortgage in NOI. Debt service comes after NOI, not inside it.
- Counting depreciation as an operating expense. It is a tax deduction, not cash, so NOI excludes it.
- Forgetting vacancy and unpaid rent. Use collected rent, not the full rent roll.
- Leaving out the owner's own costs, such as management, even if you do it yourself. A buyer will price it in.
- Comparing cap rates from different years of data. Compare like with like.
How DoorKeeping handles it
Each property has its own books, ledger and P&L, and expense accounts map to Schedule E lines, so NOI for one building comes from real rent received and real bills paid for just that building. You can ask Claude or ChatGPT for a property's NOI and see every property together. The price, loan terms and your cash invested are yours to add, since DoorKeeping does not hold them as a purchase model. These measures are not investment or tax advice.
Sources
Questions
- What is the difference between cap rate and cash-on-cash return?
- Cap rate is NOI divided by the price and ignores your loan. Cash-on-cash return is your yearly cash flow after loan payments divided by the cash you invested, so it depends on your financing.
- Does NOI include the mortgage payment?
- No. NOI is income minus operating expenses, before debt service, depreciation and income tax.
- Which number should I use to value a building?
- Cap rate is the usual starting point for value because it uses NOI and the price, not the loan. Use cash-on-cash to judge how your own financing affects your return.