The cash-on-cash formula
Cap rate measures the property. Cash-on-cash measures you— specifically, the return on the dollars you actually wrote checks for. Two investors buying the same property at the same price can have radically different cash-on-cash returns based purely on how much they put down.
The 5-step process
Step 1: Compute NOI
Net operating income = gross rent − vacancy − operating expenses (taxes, insurance, management, maintenance reserve, CapEx reserve, utilities, HOA). NOT including mortgage. Full walkthrough in how to calculate cap rate.
Step 2: Compute annual debt service
Monthly mortgage payment (principal + interest only — exclude tax/insurance escrow since those are already in operating expenses) × 12.
Step 3: Calculate annual cash flow
Annual cash flow = NOI − annual debt service. This is the pre-tax cash that actually hits your bank account.
Step 4: Tally total cash invested
What you wrote checks for, before stabilization:
- Down payment. The non-financed portion of the purchase price.
- Closing costs. Title, lender fees, inspection, appraisal, transfer taxes — usually 2-4% of purchase price.
- Upfront rehab / make-ready. Anything you had to spend to make it rentable.
- Initial reserves.Some investors fund 3-6 months of debt service as an operating reserve at closing — that's real cash invested.
NOTincluded: the loan amount (that's the bank's money), nor any future repairs you'll pay out of cash flow.
Step 5: Divide
Annual cash flow ÷ total cash invested. Express as percentage.
Worked example #1: leveraged single-family
$300K property, 25% down at 7%, $2,400/mo rent, NOI from cap-rate example $12,906.
- Loan amount: $225,000
- Monthly P&I (30 year, 7%): $1,497
- Annual debt service: $17,964
- Annual cash flow: $12,906 − $17,964 = −$5,058
- Cash invested: $75K down + $9K closing + $5K make-ready = $89,000
- CoC: −$5,058 ÷ $89,000 = −5.7%
Negative CoC means you're writing a check every month to own this property. That can still make sense if you believe in strong appreciation, but in 2026 it's a hard sell — bidding for negative cash flow on a 4.3% cap rate with 7% mortgage rate is paying for hope.
Worked example #2: same property with more leverage
Same $300K property, but with a DSCR loan at 80% LTV / 7.5%.
- Loan amount: $240,000
- Monthly P&I (30 year, 7.5%): $1,678
- Annual debt service: $20,136
- Annual cash flow: $12,906 − $20,136 = −$7,230
- Cash invested: $60K down + $9K closing + $5K make-ready = $74,000
- CoC: −$7,230 ÷ $74,000 = −9.8%
More leverage made the deal worse, not better — because the mortgage rate (7.5%) is higher than the cap rate (4.3%). This is negative leverage in action. The cap rate / mortgage rate spread is the single biggest driver of whether leverage helps or hurts.
Worked example #3: a real deal in a higher-cap market
$180K Tier 3 single-family, $1,800/mo rent, 25% down at 7%. Cap rate is ~8% on the same expense methodology.
- NOI (~8% cap): ~$14,400
- Loan: $135K at 7% / 30 = $898/mo P&I
- Annual debt service: $10,776
- Annual cash flow: $14,400 − $10,776 = $3,624
- Cash invested: $45K down + $5.4K closing + $3K make-ready = $53,400
- CoC: $3,624 ÷ $53,400 = 6.8%
8% cap, 7% mortgage rate, 1 point of positive leverage on 75% LTV — gets you a 6.8% CoC return. Not spectacular, but a real cash-flowing deal. Tier 3 markets carry vacancy and tenant risk you don't get in Tier 1, so a 6-8% CoC is often the realistic ceiling without value-add.
The trap most calculators fall into
The two biggest CoC mistakes:
- Forgetting closing costs in cash invested.A 25% down payment is the headline number, but the actual cash out of pocket is 27-30% once you add closing. Skipping closing inflates CoC by 10-15%.
- Using gross rent in cash flow instead of NOI.Subtracting mortgage from gross rent — instead of from NOI — produces a cash flow number that ignores vacancy, maintenance, and CapEx. The CoC looks 30-50% better than reality.
Related reading: How to calculate cap rate, Cap rate vs cash-on-cash vs DSCR, Cash-on-cash vs IRR.
FAQ
What's the cash-on-cash return formula?
Cash-on-cash (CoC) return = annual pre-tax cash flow ÷ total cash invested. Annual cash flow = NOI − annual debt service (12 × monthly mortgage payment). Total cash invested = down payment + closing costs + upfront rehab + initial reserves. Express the result as a percentage. Year 1 CoC is the standard quoted number; it changes over time as rents grow but cash invested stays fixed.
What counts as 'total cash invested'?
Everything you put into the deal before it stabilizes: (1) down payment, (2) closing costs (typically 2-4% of purchase price — title, lender fees, inspections, appraisal, transfer taxes), (3) any upfront rehab or make-ready costs to make it rentable, (4) any operating reserves you fund at closing. NOT included: the loan amount (that's the bank's money), or future repairs you'll pay out of cash flow.
What's a good cash-on-cash return?
Investor benchmarks vary, but rough guidance: under 4% suggests you're betting on appreciation; 4-8% is conservative buy-and-hold territory; 8-12% is solid in most markets; 12%+ usually means heavy leverage, secondary markets, or value-add. The 'right' CoC depends on what you're optimizing — a 6% CoC in Austin with strong appreciation often beats a 14% CoC in a declining Midwest market once you factor in vacancy risk and capital appreciation. Don't chase CoC for its own sake.
How does cash-on-cash return differ from cap rate?
Cap rate is unlevered yield (NOI ÷ price) — it ignores financing entirely. Cash-on-cash is levered return (cash flow ÷ cash invested) — it bakes in your specific financing. When the mortgage rate is below the cap rate, leverage amplifies returns (positive leverage) and CoC exceeds cap rate. When the rate is above the cap rate, leverage hurts (negative leverage) and CoC drops below cap rate. In 2026 with rates at 6.5-7.5% and many markets trading at 5-6% cap rates, leverage is often negative — a sign that buyers are paying for expected appreciation, not yield.
Should I include principal paydown in cash flow?
No — at least not in standard cash-on-cash. CoC measures actual cash hitting your pocket, and principal paydown isn't cash you receive. It's wealth accumulation (equity built), so it counts toward total return, not cash-on-cash return. If you want a combined metric, look at IRR or 'equity return' (cash flow + principal paydown + appreciation) ÷ cash invested. CoC stays purely about cash.
Why does year-1 cash-on-cash matter if rents grow?
Year 1 is the moment of decision: it's when you're deciding whether to buy. The CoC you can actually verify against current rents is the year-1 number. CoC growth in years 2-10 depends on rent growth assumptions you can't verify — those are projections. Underwrite to year 1 actuals; treat the trajectory as a bonus, not the basis for the buy decision.