How to Calculate Rental Property ROI (Cap Rate vs. Cash-on-Cash Return)

Investing in real estate can build long-term wealth, but how do you know if a rental property is actually a good deal? To make smart decisions, you need to understand the difference between **Capitalization Rate (Cap Rate)** and **Cash-on-Cash Return**.

Net Operating Income (NOI): The Foundation

Before you calculate returns, you need your property's **Net Operating Income (NOI)**:

**NOI = Gross Rental Income − Operating Expenses**

*Note: Operating expenses do NOT include mortgage payments (debt service) or capital expenditure (CapEx) reserves.*

1. Capitalization Rate (Cap Rate)

Cap Rate estimates the natural return of a property as if you paid cash in full. It helps you compare different properties without loan terms getting in the way.

**Cap Rate = (Annual NOI ÷ Property Purchase Price) × 100**

Example - Purchase Price: **$250,000** - Annual NOI: **$20,000**

**Cap Rate = ($20,000 ÷ $250,000) × 100 = 8.0%**

A Cap Rate between 5% and 10% is typical for stable real estate markets.

2. Cash-on-Cash Return

If you use a mortgage (leverage) to buy the property, Cash-on-Cash return is the most important metric because it calculates the return on the actual money you outlaid.

**Cash-on-Cash Return = (Annual Cash Flow ÷ Total Cash Invested) × 100**

**Annual Cash Flow = NOI − Annual Mortgage Payments**

**Total Cash Invested = Down Payment + Closing Costs + Rehab Cost**

Example - Total Cash Invested: **$60,000** - Annual Cash Flow (after paying mortgage): **$6,000**

**Cash-on-Cash Return = ($6,000 ÷ $60,000) × 100 = 10.0%**

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