Two metrics dominate real estate investment analysis: capitalization rate (cap rate) and cash-on-cash return. Understanding both — and when to use each — is foundational to analyzing any deal.
Capitalization Rate (Cap Rate)
Cap rate = Net Operating Income (NOI) / Property Value (or Purchase Price). Cap rate measures the property's yield as if you paid all cash. It's independent of financing — which makes it the best metric for comparing properties.
| Market Type | Typical Cap Rate | Implication |
|---|---|---|
| Coastal gateway cities (NYC, SF, LA) | 2–4% | High appreciation expected; cash flow thin |
| Major metros (Atlanta, Phoenix, Dallas) | 4–6% | Balanced cash flow and growth |
| Secondary cities (Tulsa, Memphis, Indianapolis) | 6–9% | Strong cash flow, more modest appreciation |
| Rural/tertiary markets | 8–12%+ | High cash flow, higher risk, limited liquidity |
Cash-on-Cash Return (CoC)
CoC = Annual Cash Flow / Total Cash Invested. Unlike cap rate, CoC accounts for your actual financing. It answers: 'What return am I getting on the money I actually put in?' This is the metric that shows how leverage affects your return.
Example: A property with a 5% cap rate purchased with 25% down at a 7% interest rate may produce a 4–6% CoC return. The same property purchased with 40% down would produce a lower CoC return because you've invested more equity.
Which Metric to Use When?
- Use cap rate to: compare properties regardless of financing, assess market pricing, value properties using the income approach.
- Use CoC return to: evaluate how your specific financing affects returns, compare your real estate investment to other uses of your capital, decide between different financing scenarios.
Buy-and-hold investors often target 6–8% CoC in most markets. BRRRR investors target 10%+ CoC after recycling capital. Appreciation-focused investors in growth markets may accept 2–4% CoC betting on price gains.