Cash-on-Cash Return vs Cap Rate vs IRR: Which Metric to Use
Cash-on-cash return is a rental property’s annual pre-tax cash flow, after the mortgage payment, divided by the cash you put into the deal. A building that leaves $15,000 a year after debt service on $630,000 of invested cash has a cash-on-cash return of about 2.4%. It measures what your own money earns in a year, which makes it the one common metric that changes with how you finance the purchase.
That is also its limit. Cash-on-cash looks at a single year and ignores loan paydown, appreciation, taxes and the eventual sale. This guide shows the formula, works one hypothetical fourplex through several financing choices, and compares cash-on-cash with cap rate, IRR, DSCR and the gross rent multiplier, so you can tell which number answers which question. It’s part of our investment property guides.
The cash-on-cash formula
The formula has two parts, and both need care.
- Annual pre-tax cash flow = net operating income (NOI) minus annual debt service (principal and interest).
- Total cash invested = down payment plus closing costs, loan fees and any repairs or improvements you pay for in cash at the start.
- Cash-on-cash return = annual pre-tax cash flow divided by total cash invested.
Two shortcuts distort it. Leaving closing costs and immediate repairs out of the denominator flatters the result. Using a seller’s NOI instead of your own, with the seller’s old property tax bill and no management fee, inflates the top line. Our guide to calculating net operating income shows how to rebuild NOI at your price.
A worked example: one fourplex, four ways to finance it
Every figure here is hypothetical, chosen to show the method; none is a market rate, rent or price. The building is the illustrative fourplex used in our NOI and cap rate guides: a $1,500,000 price and $83,338 of buyer’s NOI, about a 5.6% cap rate. Assume $30,000 of closing costs paid in cash and 30-year amortizing loans unless noted.
| Scenario (hypothetical) | Loan | Annual debt service | Cash invested | Cash flow | Cash-on-cash |
|---|---|---|---|---|---|
| All cash | None | $0 | $1,530,000 | $83,338 | 5.45% |
| 60% loan at 6.5% | $900,000 | $68,263 | $630,000 | $15,075 | 2.39% |
| 60% loan at 5.0% | $900,000 | $57,977 | $630,000 | $25,361 | 4.03% |
| 40% loan at 6.5% | $600,000 | $45,509 | $930,000 | $37,829 | 4.07% |
The cap rate is the same 5.6% in every row, because cap rate ignores financing. Cash-on-cash moves a lot. In this example every loan lowers it below the all-cash 5.45%, because each loan costs more each year than the property yields.
Leverage: when a loan helps and when it hurts
The quickest test is the loan constant: annual debt service divided by the loan amount. On a 30-year amortizing loan at 6.5%, the constant is about 7.6%; at 5.0%, about 6.4%. Compare it with the cap rate.
- Positive leverage. If the loan constant is below the cap rate, each borrowed dollar earns more than it costs, and borrowing raises cash-on-cash.
- Negative leverage. If the loan constant is above the cap rate, as in every loan row above, borrowing lowers cash-on-cash. More leverage makes it worse, not better.
- Neutral. If they are about equal, leverage mostly adds risk without adding current yield.
Interest-only terms lower the constant to the interest rate itself. A hypothetical $900,000 interest-only loan at 6.5% would cost $58,500 a year; that 6.5% constant is still above the 5.6% cap rate, so cash-on-cash would be about 3.94%, below all cash.
At a hypothetical 4.5% interest-only rate, debt service falls to $40,500 and the constant drops below the cap rate. That leaves $42,838 of cash flow on $630,000 invested, a 6.80% return, above the all-cash figure. The trade-off is that no principal is repaid, so the full balance is due at maturity or refinance.
Negative leverage doesn’t make a deal bad. It means the investor is relying on rent growth, loan paydown or appreciation rather than current cash flow. In California, rent growth on many units is limited by the state rent cap and local ordinances, so check how fast NOI can legally rise before counting on it; see our AB 1482 guide for landlords.
Cash-on-cash vs cap rate, IRR, DSCR and GRM
Each metric answers a different question. Using the wrong one for the job, such as judging a leveraged purchase by its cap rate alone, leads to bad comparisons.
| Metric | Formula | What it tells you | What it ignores |
|---|---|---|---|
| Cash-on-cash return | Pre-tax cash flow ÷ cash invested | What your equity earns this year, with your financing | Loan paydown, appreciation, taxes, sale costs, timing beyond one year |
| Cap rate | NOI ÷ price | The property’s unleveraged yield; a way to compare buildings and estimate value | Financing, growth, capital costs |
| IRR | The discount rate that makes the present value of all cash flows, including the sale, equal the cash invested | Total return over the whole hold, with timing | Depends heavily on the assumed sale price and hold period |
| DSCR | NOI ÷ annual debt service | Whether income covers the loan; lenders use it to size loans | Return on equity |
| Gross rent multiplier | Price ÷ gross annual rent | A fast screen for comparing similar buildings | Vacancy, expenses and financing |
For the fourplex, the gross rent multiplier is about 11.2 ($1,500,000 divided by $134,400 of gross potential rent), and the DSCR on the 60% loan at 6.5% is about 1.22. Our cap rate guide explains how cap rates turn NOI into value, and our page on DSCR loans in California explains how lenders size debt from coverage.
Why IRR can rise while cash-on-cash falls
Extend the 60% loan at 6.5% over a hypothetical five-year hold. Assume NOI rises 3% a year, the building sells at the end of year five for $1,700,000, and selling costs are 5%. Cash flow grows from $15,075 in year one to $25,534 in year five, and the loan balance falls to about $842,500.
- Leveraged: $630,000 in, annual cash flows, then about $772,500 of net sale proceeds after the loan payoff. IRR is about 7.1%.
- All cash: $1,530,000 in, the full NOI each year, then $1,615,000 of net sale proceeds. IRR is about 6.7%.
Year-one cash-on-cash favors all cash, 5.45% against 2.39%, yet the leveraged IRR is higher in this example because appreciation and loan paydown accrue to a smaller equity base. Change the sale price assumption and the answer can flip. That’s why an IRR is only as reliable as the exit assumptions behind it, and why it’s worth running a downside case with no appreciation.
IRR has two other blind spots: it assumes interim cash flows are reinvested at the same rate, and a percentage says nothing about the dollar size of the gain. The Corporate Finance Institute points to modified IRR (MIRR) as one response to the reinvestment issue.
Why the pre-tax label matters
Cash-on-cash leaves out income tax, and a rental’s taxable income is not the same as its cash flow. IRS Publication 527 says rent generally counts as gross income, mortgage interest on a rental is deductible but principal payments are not, and the cost of the building, though not the land, is recovered through yearly depreciation deductions.
So the principal part of each loan payment lowers cash flow without lowering taxable income, while depreciation lowers taxable income without using cash. Two buildings with the same cash-on-cash return can leave different amounts after tax.
What is a good cash-on-cash return?
There is no standard figure. A reasonable target depends on what else your money could earn, the risk of the property, how much you are counting on appreciation, and how long you plan to hold. A low or even negative first-year return can make sense for an investor buying for long-term value in a supply-constrained market, as long as reserves cover the shortfall.
A few practical tests help more than a target number:
- Does the property cover its debt and reserves in year one without new cash from you?
- Does the return still work at the rent increases state and local law actually allow?
- What happens to cash flow if the loan resets or must be refinanced at a higher rate?
- How much of the projected total return comes from the assumed sale price?
Our rental property analysis worksheet walks through each input in order, including the reassessed property tax; for how reassessment works, see California property tax for investors.
Cash-on-cash in common investor strategies
- Small multifamily with conventional financing. Compare lenders’ rates, terms and reserves; our guide to financing 2-4 unit properties covers the options.
- Apartment buildings. Commercial loans bring different amortization, prepayment and coverage terms; see apartment building loans.
- BRRRR and value-add. When a refinance pulls cash back out, the denominator shrinks and the return on remaining cash can rise sharply; our BRRRR method guide shows the mechanics.
- Exchange buyers. Cash-on-cash on exchanged equity still matters, but the tax deferral is part of the return; see our 1031 exchange guide.
Diamond may refer you to partners we work with; you’re free to choose any provider.
The examples above are a teaching tool, not financial or tax advice; a CPA or financial adviser can tell you how leverage, depreciation and income taxes change the return for your own holdings.
Questions people ask
How do you calculate cash-on-cash return?
Subtract annual debt service from net operating income to get pre-tax cash flow, then divide by the total cash you invested, including the down payment, closing costs and upfront repairs.
What is the difference between cash-on-cash return and cap rate?
Cap rate is NOI divided by price and ignores financing, so it describes the property. Cash-on-cash is cash flow after the mortgage divided by your cash, so it describes your investment with your loan.
What is a good cash-on-cash return?
There’s no universal number. Judge it against your alternatives, the property’s risk and how much of your expected return depends on appreciation and the sale.
Cash-on-cash return vs IRR: which should I use?
Use cash-on-cash for current income in a single year and IRR for total return over the hold. IRR includes loan paydown and sale proceeds but depends on your exit assumptions, so test more than one sale price.
Can cash-on-cash return be negative?
Yes. If debt service exceeds NOI, cash flow is negative and so is the return. That happens when the loan costs more each year than the property yields and the loan is large.
Does cash-on-cash return include appreciation or tax benefits?
No. It is a pre-tax, single-year cash measure. Appreciation, loan paydown and depreciation show up in IRR or an after-tax analysis.
What is the gross rent multiplier?
Price divided by gross annual rent. It’s a quick screen for comparing similar buildings in the same area, but it ignores expenses and vacancy, so follow it with an NOI-based analysis.
If you’re weighing a rental or apartment purchase and want a second set of eyes on the numbers, we can walk through the NOI, financing and exit assumptions with you. Read how we approach apartment purchases or contact Diamond.
Sources & notes
- Corporate Finance Institute: Cash on Cash Return
- Corporate Finance Institute: Internal Rate of Return (IRR)
- Internal Revenue Service: Publication 527 (2025), Residential Rental Property
All figures on this page are hypothetical illustrations calculated from stated assumptions. They are not market data, rate quotes or projections.
Last reviewed October 2026 by Matthew Martinez.
