The Difference Between Cash On Cash And Cap Rate

Commercial real estate can be confusing. What's the difference between cash on cash and cap rate?
In this video, I break it down for you in a way that is easy to understand. Once you know the basics, you'll be able to make better decisions about your commercial property investments!
Matador Investments is a commercial real estate private equity company that specializes in the ownership and operation of Class B & C commercial properties within the Texas and Oklahoma markets. Our niches are low-coverage industrial warehouses, manufacturing facilities, shallow/small bay, and multi-tenanted assets. We are committed to building long-term relationships with our investors, investment partners, tenants, and colleagues. We base our relationships and decisions on trust, forthrightness, and respect to preserve the highest standards of integrity and professionalism.
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[@Walina-gv9ph]

1. A cap rate is not a return metric.
2. The cap rate is a valuation metric.
3. The cap rate is the same if you pay cash or finance 100%.
4. Cash on Cash is a return metric.
5. If you do not use leverage then the CoC return will be the same as the cap rate by happenstance.
6. But they measure different things.
7. The cap rate will measure the value of NOI. V=i/r is the formula.
8. If you buy $1 NOI at 5% cap rate you paid $20. If you bought at a 10% cap rate you paid $10.
9. f you use cap rates incorrectly and pay $20 in a $10 market then your cash on cash without leverage is 5%. BUT you overpaid by double!!! Still think you will be getting a 5% CoC return?
10. NOPE!

[@TheWestAspen]

Completely agree. Cash on Cash, when leverage is in play is so completely irrelevant, doesn't even belong in the same chapter of the book. Now, do we want to talk about the composition of cap rates? The component that is the baseline/risk free, plus the risk premium spread, and how that is changing, now I'm listening.

[@oshitomaha]

@@TheWestAspenwhy would cash on cash be irrelevant when use leverage? Wtf??

[@TheWestAspen]

@@oshitomaha The concept of a cap rate is to have a metric that can be applied across asset classes to understand risk premium (outside of leverage). When leverage is added to a deal, it manipulates the cash-on-cash metric. Let's say a MF property owned without leverage produces a cash-on-cash return of 6.0%, now apply high leverage, and lets say the cash on cash return is 17.0%. It is the same property, producing the same NOI, the difference is leverage. Some dude will be out there touting a cash-on-cash return of 17.0%, and everyone thinks it's a great deal, but he doesn't disclose leverage of 95% on the property, making cash-on-cash irrelevant in understanding the underlying property. The cap rate metric eliminates this component, thereby allowing an investor the capacity to assess risk premium based on the asset at hand, not the deals capital structure.

[@oshitomaha]

⁠@@TheWestAspenbut that’s the whole point! Cash on cash is relevant because your ability to control the property and getting a return on your money for only 5% (95% leverage) is amazing. You can even do the same tactic for other properties as well. To me, a very small amount of cash on your end just to control the property, while getting a decent return on said cash is very relevant. Let alone the tax benefits, appreciation, etc.

[@TheWestAspen]

@@oshitomaha You're interested in capital structure is what you are telling me. I'm not interested in unpacking the presented cash on cash metric being marketed on the 30-deals I will look at before I purchase one. I'm interested in comparing the risk profile on deals 1-30 in a time efficient manner, cap rate metric allows for that. Cash on cash is irrelevant. Furthermore, people who believe 95% leverage is the best thing since sliced bread are playing rookie ball. Don't believe me, go check out McElroys current deal in Henderson Nevada, $97MM deal with $40MM in equity. Want to look further, go check out any of the apartment REIT's balance sheets. 95% leverage doesn't see you out of the next correction. Good luck out there, may your rent roll always be full..;)

[@Walina-gv9ph]

This is all wrong. You are confusing 2 different metrics. Cap rate values NOI and CoC is a rate of return.