Cap Rate vs Cash-on-Cash, Simplified

Ever look at a 5 percent cap rate and wonder why the monthly cash flow still comes up short? You are not alone. If you are evaluating rentals in Merrimac, the Haverhill corridor, or coastal Essex County, two metrics do most of the heavy lifting: cap rate and cash-on-cash return. In this guide, you will see what each one means, how to calculate them step by step, and how to use them together to choose smarter deals.

Let’s dive in.

Cap rate vs cash-on-cash: plain English

Cap rate and cash-on-cash answer different questions. Knowing which question you are asking helps you pick the right metric.

What cap rate measures

• Definition: The unleveraged annual return a property generates based on current income.
• Formula: Cap rate = Net Operating Income (NOI) ÷ Purchase Price.
• What it tells you: The property’s income yield if you bought it all cash and income stayed stable. It strips out the loan, so you can compare the underlying asset across different buildings and towns.
• Where it helps: Comparing similar properties, gauging value using market cap rates, and looking at the asset’s income potential without financing noise.

What cash-on-cash measures

• Definition: Your annual pre-tax cash return relative to the actual cash you put in.
• Formula: Cash-on-Cash = Annual Cash Flow After Debt Service ÷ Total Cash Invested.
• What it tells you: Year-one cash yield based on your down payment, closing costs, and loan. It reflects your financing terms and whether the property helps or hurts your monthly budget.
• Where it helps: Planning liquidity and cash flow, comparing leveraged deals, and understanding how interest rates impact returns.

Related terms worth knowing

• NOI: Effective Gross Income minus operating expenses. It excludes loan payments and income taxes.
• DSCR: Debt Service Coverage Ratio = NOI ÷ Annual Debt Service. Lenders often look for 1.20 to 1.35 or higher.
• GRM: Gross Rent Multiplier = Price ÷ Gross Annual Rent. Fast screen, not a full analysis.
• IRR and Equity Multiple: Longer-term metrics that include multi-year cash flow and sale proceeds.

How to calculate cap rate

Use consistent, local inputs. Then follow these steps:

1. Estimate Potential Gross Rent for all units at market rates.
2. Apply a vacancy factor to get Effective Gross Income (EGI). For many North Shore properties, a common assumption is 4 to 8 percent vacancy. Use local data when possible.
3. Add other income if applicable, such as parking or laundry.
4. Subtract operating expenses you pay as the owner: property taxes, insurance, landlord-paid utilities, maintenance and repairs, management fees, and reserves for capital items.
5. The result is NOI. Then compute NOI ÷ Purchase Price for the cap rate.

Cap rate is clean and simple. Just remember it ignores your mortgage, one-time costs, and future appreciation.

How to calculate cash-on-cash

Cash-on-cash layers in your financing and actual cash invested. Use this sequence:

1. Start with NOI.
2. Subtract annual debt service. This is principal and interest for the year plus any loan-related escrows or fees that hit cash flow.
3. The result is Annual Cash Flow After Debt Service.
4. Add up your Total Cash Invested: down payment, closing costs, and any initial rehab or reserves you fund at closing.
5. Compute Annual Cash Flow ÷ Total Cash Invested for cash-on-cash.

Note: Cash-on-cash shows a single year’s pre-tax yield. It does not include principal paydown, tax benefits, or appreciation. Use it to understand year-one cash impact, not total return.

North Shore inputs you must get right

Accurate numbers make or break both metrics. For Merrimac, Haverhill, and Essex County, focus on:

• Market rents: Pull recent listings for similar unit types and condition. Adjust for parking, utilities included, and seasonality in coastal towns. You can also review county-level benchmarks such as HUD Fair Market Rents.
• Vacancy: Many stable suburban properties in Massachusetts use 4 to 8 percent. Use higher assumptions for less desirable unit types or weaker micro-locations.
• Property taxes: Look up the current rate on the town or city assessor website. Each municipality sets its own rate.
• Insurance: Get local quotes. Coastal proximity can raise premiums. Check whether the property sits in a flood risk area and factor potential flood insurance.
• Maintenance and repairs: A common rule-of-thumb is 5 to 10 percent of EGI for routine items, plus a CapEx reserve for big-ticket components.
• Management: Self-managing can be 0 to 5 percent of collected rent. Third-party management often runs 7 to 10 percent for small multifamily.
• Utilities: If the landlord pays water, sewer, or heat, use actual averages or historical bills.
• CapEx reserves: Many investors set aside 5 to 10 percent of EGI or a per-unit annual amount.
• Financing terms: Rate, amortization, points, lender fees, and mortgage insurance all change cash-on-cash.
• Acquisition costs: Plan for 2 to 5 percent of price for typical closing costs, plus any initial rehab.

Merrimac and Essex County examples (hypothetical)

The numbers below are illustrative. They mirror how returns can look in the Merrimac and Haverhill corridor and nearby Essex County towns when you plug in realistic local assumptions.

Example A: single-family, all cash

• Purchase price: 400,000
• Monthly rent: 2,200 → Annual potential rent: 26,400
• Vacancy: 5 percent → EGI: 26,400 × 0.95 = 25,080
• Operating expenses:
  • Property tax: 4,000
  • Insurance: 1,200
  • Maintenance and repairs at 5 percent of EGI: 1,254
  • Management at 8 percent of EGI: 2,006
  • Reserves at 5 percent of EGI: 1,254
  • Total expenses: about 9,714
• NOI: 25,080 − 9,714 = 15,366
• Cap rate: 15,366 ÷ 400,000 = 3.84 percent
• Cash-on-cash with all cash: If closing costs are 2 percent, total cash invested is 408,000. CoC is 15,366 ÷ 408,000 = 3.77 percent.

Takeaway: With no loan, cap rate and cash-on-cash are nearly the same.

Example B: same property with leverage

• Loan at 75 percent LTV: 300,000; down payment: 100,000
• Rate: 6.0 percent, 30-year fixed → Annual debt service: about 21,584
• Annual cash flow: 15,366 − 21,584 = −6,218
• Cash invested: 100,000 down + 8,000 closing = 108,000
• Cash-on-cash: −6,218 ÷ 108,000 = −5.75 percent

Takeaway: The cap rate stays 3.84 percent, but the loan turns year-one cash flow negative.

Example C: small multifamily, two units

• Purchase price: 450,000
• Rents: 1,600 and 1,500 → Annual potential rent: 37,200
• Vacancy: 7 percent → EGI: 37,200 × 0.93 = 34,596
• Expenses:
  • Property tax: 4,500
  • Insurance: 1,500
  • Maintenance at 5 percent of EGI: 1,730
  • Management at 8 percent of EGI: 2,768
  • Reserves at 5 percent of EGI: 1,730
  • Total expenses: about 12,228
• NOI: 34,596 − 12,228 = 22,368
• Cap rate: 22,368 ÷ 450,000 = 4.97 percent
• Leveraged scenario at 80 percent LTV: loan 360,000; down 90,000; 6.0 percent, 30 years → Annual debt service about 25,901
• Annual cash flow: 22,368 − 25,901 = −3,533
• Cash invested: 90,000 down + 9,000 closing = 99,000
• Cash-on-cash: −3.57 percent

Rate sensitivity:

• If the rate were 4.0 percent on the same terms, annual debt service is about 20,624 → Cash flow 1,744 → CoC 1.76 percent.

Takeaway: Small multifamily can offer higher cap rates than similar single-family in the area, but cash-on-cash can still compress when rates are high.

How to use both metrics in decisions

Use cap rate and cash-on-cash together, not as either-or.

• Start with cap rate to compare the property’s income engine across options. It helps you spot under- or over-priced listings relative to income.
• Layer in cash-on-cash to see year-one cash flow with your actual down payment and rate. This is your liquidity view.
• Check DSCR if you need financing. A DSCR below a lender’s minimum can limit loan options.
• Run sensitivity for vacancy, maintenance, and rates. When rates are elevated, leverage can turn a respectable cap rate into negative cash-on-cash.

Quick worksheet you can copy

Use this simple structure to organize your numbers for a Merrimac or Essex County property.

Copy this into a spreadsheet, then build a second tab for sensitivity with different rent, vacancy, and rate assumptions.

Sensitivity checks that protect you

Before you commit, stress test your numbers.

• Interest rate: Recalculate cash-on-cash at rates plus or minus 0.5 percent. See how quickly the yield changes.
• Vacancy and maintenance: Try vacancy at 4, 6, and 8 percent. Bump maintenance and reserves by 10 to 20 percent. Watch NOI and DSCR.
• Break-even rent: Solve for the monthly rent you would need to hit your target cash-on-cash. If the required rent is unrealistic for the unit type and location, rethink the deal.
• Down payment: Test 20, 25, and 30 percent down. Larger down payments often improve cash-on-cash by lowering debt service.

Local notes for Merrimac and nearby markets

• Taxes vary by town: Always pull the current tax rate and a sample bill from the local assessor for the specific property.
• Insurance can run higher near the coast: In parts of Essex County, flood and wind exposure can increase premiums. Confirm flood zone status and price coverage accordingly.
• Tenant rules matter: Massachusetts has specific tenant protections and eviction timelines. Review landlord responsibilities and any local inspection or registration requirements before you buy.
• Inventory mix differs by micro-location: The Merrimac and Haverhill corridor includes older multifamily stock and commuter-friendly single-family homes. Coastal Essex towns see seasonal patterns. Cap rates and rents can vary materially block by block, so always use local comps.

Next steps

If you are comparing a Merrimac single-family to a small multifamily in Essex County or weighing options across the North Shore, use cap rate to judge the asset and cash-on-cash to judge your near-term cash flow. Run both, then stress test. If you want a sanity check, a second set of eyes on the numbers, or local rent and tax comps, our team is here to help.

Have questions or want a quick spreadsheet built around your scenario? Reach out to The Barnes Team for a focused, data-driven analysis and next steps tailored to your goals.

FAQs

What is the difference between cap rate and cash-on-cash for rentals?

• Cap rate shows the property’s income yield ignoring financing. Cash-on-cash shows your year-one cash yield after loan payments based on your actual cash invested.

Which metric should a beginner use first in Merrimac?

• Start with cap rate to compare the property’s income potential, then use cash-on-cash to confirm whether your financing and down payment produce acceptable year-one cash flow.

How do mortgage rates affect cash-on-cash on North Shore properties?

• Higher rates increase debt service, which can turn positive NOI into negative cash flow, compressing cash-on-cash even when the cap rate looks acceptable.

How can I estimate realistic operating expenses in the Merrimac–Haverhill corridor?

• Pull the actual tax bill, get insurance quotes, review utility history if landlord paid, and budget 5 to 10 percent of EGI for maintenance plus a CapEx reserve. Add management if you will not self-manage.

How much should I set aside for repairs and CapEx in Essex County?

• Many investors use 5 to 10 percent of EGI for routine maintenance and a similar percentage or per-unit reserve for larger capital items, adjusted for property age and condition.

Is a low cap rate but positive cash-on-cash still a good buy?

• It depends on your goals. Positive cash-on-cash supports near-term cash flow, but a low cap rate can signal a higher price relative to income. Weigh both metrics and your hold strategy.

Where can I quickly find local rent and tax data?

• Use recent rental listings for comps, HUD county-level rent benchmarks for a baseline, and the town or city assessor for property tax rates and sample bills.

Do taxes and depreciation change the “real” return?

• Yes. Tax impacts can improve after-tax returns, but they are specific to your situation. Consider consulting a CPA to model after-tax cash flow and long-term IRR.