Guides · Real estate
Rental Property Math: NOI, Cap Rate, & Cash-on-Cash Return
Three numbers describe every rental deal, and they answer three different questions. Confusing them is how people talk themselves into buildings — because one of them ignores your mortgage entirely and another exists only because of it.
NOI describes the property, not your loan
Net operating income is gross rental income minus operating expenses: taxes, insurance, management, maintenance, utilities, vacancy allowance. What it deliberately excludes is mortgage principal and interest.
That exclusion is the point rather than an oversight. NOI is meant to describe how the building performs so that two buyers — one paying cash, one borrowing 80% — compute the identical figure for the identical property. It separates the quality of the asset from the structure of your financing.
The number people get wrong is the expense side. A projection that counts only the mortgage and property tax will show cash flow that doesn't exist. Vacancy, turnover, repairs, capital reserves and management all belong in the calculation whether or not you're paying someone else to do the managing — your own time isn't free just because it's uninvoiced.
Gross rent − operating expenses. Never minus the mortgage. That's what makes it comparable between buyers.
Two returns, two questions
Cap rate is NOI divided by price. It's the unleveraged yield of the building, and its real use is comparison — between properties, and against what similar buildings in the same market are trading at. A cap rate is only meaningful relative to other cap rates nearby.
Cash-on-cash return is annual cash flow after debt service divided by the cash you actually put in. This is the one that answers 'what is my money earning?', and it's the one that moves with your mortgage.
Leverage is what separates them, and it cuts both ways. Borrowing at a rate below the cap rate lifts cash-on-cash above it; borrowing above the cap rate drags it below, and can turn a perfectly sound building into a losing investment. Neither number is the honest one on its own — the cap rate tells you whether the asset is good, cash-on-cash tells you whether your deal is.
NOI describes the building. Cap rate prices the building. Cash-on-cash measures your deal, after financing. NOI deliberately excludes debt service, which is why two buyers compute the same NOI and very different returns.