Cash on cash return vs. cap rate

[Dwayne Smith]

I’m new into RE investing. What is the difference between calculating cash on cash return vs. cap rate? And can you explain the difference

[Taylor L.]

Capitalization (cap) rate is the ratio between Net Operating Income and Price. Cap rate would also be your unlevered return on a property. That is if you bought the property cash and did not change any operations, the cap rate would be your return before taxes. Cap rate is calculated as Net operating income divided by Price. Cap rate does not factor in financing.

Cash-on-cash return is a more direct indication of your return on a particular investment. Your financing strategy is factored into the calculation of cash-on-cash return. Cash on cash return is Yearly Pre-tax cash flow divided by total cash invested. 

Your financing strategy is factored into the CoC calculation because your total cash invested is a result of your financing strategy. For example, your total cash invested will be different if you use 80% LTV financing or 65% LTV financing.

In my opinion, Cash on cash return is a more useful metric.