Cap Rate, Cash-on-Cash, and IRR: Which Rental Metric Should Actually Make the Decision?
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Ask three investors whether a rental is a good deal and you may get three answers: "it's a 6.5 cap," "it cash-flows at 9%," "the IRR pencils to 13." All three can describe the same building. None of them is the right metric. They answer different questions, and using the wrong one is how people buy properties that look great on a spreadsheet and feel terrible in year three.
Our Rental Property Calculator computes cap rate, cash-on-cash, IRR, DSCR, and break-even occupancy on the same inputs. Here is one duplex through each lens. Dollar expenses below are stated year-one assumptions so the arithmetic stays followable; the calculator will move slightly if you switch vacancy into a rate or add credit loss.
The deal
| Line | Amount |
|---|---|
| Purchase price | $420,000 |
| Closing costs + immediate repairs | $9,000 + $11,000 |
| All-in basis | $440,000 |
| Combined rent | $3,600/month ($43,200/year) |
| Operating expenses | $18,516/year |
| NOI | $24,684 |
| Down payment / loan | $105,000 / $315,000 at 6.9%, 30 years |
| Annual debt service | $24,895 |
| Cash invested | $125,000 |
Operating expenses in this example: taxes $5,000, insurance $2,300, maintenance reserve $3,200, capex reserve $2,400, property management (8% of rent) $3,456, vacancy allowance (5% of rent) $2,160.
Cap rate: the property's own yield, ignoring you
Cap rate = NOI ÷ purchase price. $24,684 ÷ $420,000 = 5.9%.
Cap rate deliberately excludes financing. It describes the property, not your deal. That makes it the right tool for two jobs: comparing properties against each other (a 5.9 cap vs. a 6.8 cap in the same submarket is a real difference), and sanity-checking asking price against the market. It cannot tell you whether you will make money, because you are probably using a mortgage — and whether leverage helps or hurts depends on the spread between cap rate and borrowing cost.
The warning on this deal is already on the page: the 5.9% cap sits below the 6.9% loan rate. That is negative leverage. The next two metrics show what it costs.
Cash-on-cash: what your actual dollars earn this year
Cash-on-cash = year-one pre-tax cash flow ÷ cash invested. Cash flow is NOI minus debt service: $24,684 − $24,895 = −$211/year. Against $125,000 invested (down payment + closing + repairs), cash-on-cash is −0.2%.
DSCR is the lender's version of the same story: NOI ÷ debt service = 0.99x. Most rental underwriting wants 1.20x to 1.25x. At 0.99x the building does not quite cover its own loan.
Cash-on-cash answers "what does my life look like as this property's owner?" Here the answer is: you feed it, slightly, every month. Its honesty is also its limit. It sees nothing past year one — no rent growth, no loan paydown, no appreciation, no tax. Judging a long-hold rental on cash-on-cash alone is like judging a career on the first paycheck.
IRR: the whole story, priced per year
Internal rate of return folds every cash flow across the hold — year-one carry, later years, principal the tenants pay down, and sale proceeds — into one annualized return. Model a 7-year hold, 3% annual appreciation (sale near $517,000), 6% selling costs, and a remaining loan of about $287,000. Equity back at sale is roughly $199,000 against $125,000 in. Hold year-one cash flow roughly flat (rent growth offset by expense growth) and the pre-tax IRR lands around 6.7%.
That is not a disaster. It is also hard to justify: a mid-single-digit IRR with concentrated, illiquid, leveraged risk and negative monthly carry, next to diversified index funds that have historically delivered a similar return without the 2 a.m. plumbing call. IRR is only as good as the appreciation and rent-growth guesses inside it. Run the same hold at 0%, 2%, and 4% appreciation and you can see which assumption the decision secretly depends on.
| Appreciation | Sale (year 7) | Equity after 6% costs and the loan | Pre-tax IRR |
|---|---|---|---|
| 0%/year | $420,000 | ~$108,000 | −2.2% |
| 2%/year | $482,000 | ~$167,000 | 4.1% |
| 3%/year | $517,000 | ~$199,000 | 6.7% |
| 4%/year | $553,000 | ~$233,000 | 9.2% |
If the deal only looks acceptable at 4% appreciation, you are not buying a rental. You are speculating with a very illiquid ticket.
Side-by-side on this duplex
| Metric | This deal | Question it answers |
|---|---|---|
| Cap rate | 5.9% | Is the property priced sanely vs. its own NOI? |
| Cash-on-cash | −0.2% | Will year one feed you, or will you feed it? |
| DSCR | 0.99x | Does NOI cover the loan the way a lender scores it? |
| IRR (7-year, 3% appr.) | ~6.7% | Is this a good use of the $125,000 over the full hold? |
A deal worth doing usually clears all three for its strategy: priced near market (cap rate), survivable (cash-on-cash at least zero, DSCR the lender will fund, reserves in the bank), and rewarding (IRR beating your realistic alternative by enough to pay for the risk and the work).
Which metric decides?
- Pricing problem (is the ask in line with other buildings?): cap rate, versus comps in the same submarket.
- Carry problem (can you hold this if rent dips or a unit sits?): cash-on-cash and DSCR. If both are negative, the 2 a.m. problem arrives before the appreciation story does.
- Capital-allocation problem (is this the best use of $125,000 for seven years?): IRR, stress-tested at 0%, 2%, and 4% appreciation.
What would flip this deal
The building is not doomed. The structure is. Two changes that the calculator will show immediately:
- More equity, same price. At 40% down the loan falls to $252,000. Debt service drops to about $19,916/year, year-one cash flow flips to about +$4,768, and cash-on-cash is about 2.5% on $188,000 invested. You bought your way out of negative leverage. You also tied up another $63,000.
- A lower ask, same rent. At $380,000 and the same 25% down, cap rate rises to about 6.5% and year-one cash flow turns positive (about +$2,160, cash-on-cash ~1.9%). Price was doing more damage than the rent roll.
Neither change is a slogan. Both are inputs. Run them before you negotiate, not after you are in contract.
The mistakes that flatter bad deals
- Omitting capex and vacancy reserves. Drop the $4,560 of reserves above and this deal's cash flow flips positive — on paper. Roofs disagree.
- Using asking rent instead of market rent. Verify with actual comparables. The calculator's rent estimates are a cross-check, not a substitute for local comps.
- Counting appreciation as certain. Appreciation is the dessert, not the meal. The table above is the test: if 0–2% appreciation makes the IRR worse than a boring index fund, the rental is not carrying its own weight.
Rules that hold regardless of which metric you favor
- Name the question before you pick the number. Cap rate cannot bless a cash-flow hole. Cash-on-cash cannot bless a 4%-appreciation-only IRR.
- Keep reserves outside the down payment. A starter repair fund is what keeps a vacant month from becoming a credit-card month.
- Re-run DSCR the way the lender will. If you need 1.25x and the building prints 0.99x, you do not have a "tight" deal. You have a financing problem.
Educational content only — not investment, tax, or legal advice. Figures are illustrative and pre-tax. Actual lender overlays, local taxes, and selling costs will move the result.