Should cash-on-cash return be higher than cap rate?

[Henry Le]

I'm having a hard time figuring out how people generate double-digit cash-on-cash returns with commercial properties.  Can someone explain if my math below is correct?

Let's say there's a commercial property selling for $1,000,000. The cap rate is 7%, so NOI is $70,000.

You put 50% down at 4.5% interest rate for 10 years, amortized over 25 years.  So the annual debt service is about $35,000.  

That leaves you with cash flow of $35,000 before taxes.  So the cash-on-cash return is 7%, ($35k divided by $500k).  

If even you put 20% down, the cash-on-cash return increases slightly to 7.5%.  ($55k in debt service, leaving $15k in cash flow).

Do you have to buy at a much higher cap rate or rely on increasing the NOI overtime? Many thanks in advance.

[Mike Dymski]

Yes, the big ticket returns come from adding value.  Every $25/mth increase in rent is an increase in the property value of that unit by $4,300 using the 7% cap you mentioned above ($25 x 12 months / 7%) (have to factor in the cost of the value add, if any).  Multiply that by the number of units and/or larger rent increases and you find the driving force behind value add investors.