Cash-on-cash vs cap rate for multifamily investors

A question that comes up constantly when investors review their first multifamily deal: do you look at cap rate or cash-on-cash return? The honest answer is both, but they tell you entirely different things. Confusing them is one of the most common underwriting mistakes I see when investors evaluate a Wichita, KS deal for the first time.

The numbers below are illustrative, not from a specific transaction. The mechanics are real.

What is cap rate, and why does financing not belong in it?

Cap rate. The capitalization rate is the ratio of a property's net operating income (NOI) to its purchase price or current market value. The formula is straightforward:

Cap rate = NOI / Property value

No mortgage payment. No down payment. No investor-specific financing terms. Cap rate is a property metric, not an investor metric. It answers one question: if you bought this building for all cash, what return would the income produce?

This is exactly why cap rate is the right tool for comparison shopping. When you look at a 10-unit in Wichita's College Hill submarket at a 7% cap rate and an 8-unit in the Riverside area at a 6.5% cap rate, you can evaluate them on equal footing even if you plan to finance both differently. Remove the debt, remove the personal variables, and you see what the property itself actually earns.

Cap rate also moves inversely with price. If a property's NOI holds steady and the market pays more for it, the cap rate compresses. This is why "cap rate compression" signals rising asset values: buyers accept less return per dollar of income because they expect future appreciation or rent growth.

What is cash-on-cash return, and why does it depend on how you finance the deal?

Cash-on-cash return. This metric divides your annual pre-tax cash flow by the actual dollars you invested out of pocket:

Cash-on-cash = Annual pre-tax cash flow / Total cash invested

Total cash invested is your down payment plus closing costs. Annual pre-tax cash flow is NOI minus your annual debt service (mortgage principal and interest payments combined).

Here is why two investors can look at the same 7% cap rate deal and land at completely different cash-on-cash returns:

• Investor A puts 40% down and locks a 5.5% rate: she gets a 6.8% cash-on-cash return.
• Investor B puts 20% down at a 7.5% rate: he gets a 1.9% cash-on-cash return on the same property.

Same deal. Same cap rate. Different financing terms, different outcomes. Cash-on-cash is personal. It reflects your terms, your down payment, and the rate environment you are operating in.

How does the math play out on a Wichita 12-unit example?

Worked example (illustrative, not a specific transaction; the mechanics are real): a 12-unit B-class building in Wichita, 1975 vintage, asking price $840,000.

The property income stack:

• Average rents: $875 per unit per month
• Gross rents: $126,000 per year
• Vacancy (7%): ($8,820)
• Effective gross income: $117,180
• Operating expenses (38% of EGI): ($44,528)
• Net operating income: $72,652

The cap rate check:

Cap rate = $72,652 / $840,000 = 8.65%

For a Wichita B-class property in current market conditions, that is a solid going-in return. The property income covers the price well.

Now add financing, Scenario 1: 25% down, 7.25% rate, 30-year amortization.

• Down payment: $210,000
• Loan amount: $630,000
• Monthly payment: approximately $4,300
• Annual debt service: approximately $51,600
• Pre-tax cash flow: $72,652 - $51,600 = $21,052
• Total cash invested: $210,000 down + $12,600 closing costs = $222,600
• Cash-on-cash return: $21,052 / $222,600 = 9.45%

When we underwrite a deal like this 12-unit, an 8.65% cap rate producing 9.45% cash-on-cash tells a consistent story: the property income is meaningfully stronger than the cost of the debt. That is positive leverage working in your favor.

Scenario 2: Same property, same down payment, but rate moves to 8.5%.

• Monthly payment: approximately $4,845
• Annual debt service: approximately $58,140
• Pre-tax cash flow: $72,652 - $58,140 = $14,512
• Cash-on-cash return: $14,512 / $222,600 = 6.52%

Same property, same cap rate, same equity in. Cash-on-cash drops nearly 3 full percentage points because of rate. The deal still works, but the gap between cap rate and cash-on-cash narrows significantly.

When does the spread between cap rate and cash-on-cash signal danger?

The spread narrows as interest rates rise toward the cap rate. When your mortgage rate approaches or exceeds the property's cap rate, cash-on-cash turns negative. This is called negative leverage: financing the deal makes your return worse than buying for all cash.

Negative leverage scenarios:

• 7% cap rate + 7.5% mortgage rate at 80% LTV: debt service proportionally consumes more than the added leverage earns, cash-on-cash compresses sharply toward zero or below.
• 7% cap rate + 8.5% mortgage rate at 80% LTV: likely negative cash-on-cash, meaning you are subsidizing the property out of pocket every month.

Positive leverage scenario:

• 8.65% cap rate + 7.25% mortgage rate at 75% LTV: debt service is well-covered, cash-on-cash improves with leverage rather than eroding it.

When we review deals in the Wichita market for Kallpa's investment buy box, the spread between cap rate and prevailing loan rates is one of the first signals we check. The moment a deal's cap rate dips below the available mortgage rate, we scrutinize it closely before committing. Leverage that amplified returns in 2020 and 2021 becomes a monthly drag in a higher-rate environment.

For a current look at what cap rates we are actually seeing by Wichita submarket, the Wichita cap rates by neighborhood post has the submarket breakdown with the ranges we price to.

What does neither metric tell you?

Cap rate and cash-on-cash are both single-year snapshots. Neither accounts for:

Appreciation. A Wichita B-class building that grows in market value at 3% annually adds real total return over a 10-year hold on top of cash flow. Neither metric captures it.

Principal paydown. Every mortgage payment builds equity. On a $630,000 loan at 7.25% over 30 years, you pay down roughly $97,000 in principal across the first 10 years. That equity accrues to you whether or not the property appreciates.

Tax benefits. Residential multifamily is depreciated over 27.5 years using the straight-line method, per IRS Publication 946. For a property placed in service at $840,000 (excluding land), the annual depreciation deduction approaches $26,000, which shelters a meaningful portion of cash flow from ordinary income tax.

To capture the full picture, investors run an internal rate of return (IRR) projection that discounts all future cash flows, the eventual sale proceeds, and the tax benefits back to today's dollars. IRR is the complete return metric; cap rate and cash-on-cash are the front-end filters that tell you whether a deal is worth modeling in depth.

For investors exploring JV structures with Kallpa, the equity partner guide covers how IRR and preferred returns are structured in a joint venture deal.

Which metric should you lead with when evaluating a Kansas deal?

Lead with cap rate to screen. Use it to eliminate properties that do not meet your minimum income threshold before spending time on financing scenarios. Cap rate requires only three inputs: the NOI (which you derive from the rent roll and T-12 operating statement) and the asking price. It is the fastest first filter.

Then run cash-on-cash with your actual financing terms to confirm the deal works for your specific situation. If cash-on-cash falls short of your target, the deal needs one of three things: a lower purchase price, better financing terms, or a different capital structure.

Most new investors I talk through deals with are targeting at minimum 6% to 8% cash-on-cash to justify the management overhead of a multifamily property. That threshold shifts based on hold period, local market norms, and how much appreciation you are willing to bet on.

The Kansas multifamily deal analysis post covers the full underwriting walk once you are past the cap rate and cash-on-cash filters, including the T-12 normalization and expense recast steps. If you are still building out the JV model, the passive investing in Kansas guide covers how equity splits and preferred returns layer on top of these metrics.

If you want to talk through how a specific deal you are looking at pencils out, reach Jose directly. When you call, you are talking to the person who runs the underwriting, not an analyst or associate.