Real estate ROI isn't one number — cap rate (no loan) tells you if the price is fair, cash on cash (with loan) tells you if the financing works, and IRR tells you what a 5-year hold with sale really earns. This complete investor's guide shows how to calculate each, with NOI from scratch, a $300K duplex walkthrough, and which metric to use when — no finance degree needed.
- NOI (foundation):
Effective Income ($28,500) + Other ($1,200) = $29,700 − Operating Expenses $11,376 = $18,324 NOIper year — excludes debt, tax, depreciation. Get this right or every ROI is wrong. - Cap Rate (market, unlevered):
Cap = NOI / Value→ $18,324 / $300,000 = 6.11%. Compare properties without leverage; inverseValue = NOI / Cap. Use our cap rate calculator (NOI ÷ value or value from NOI ÷ cap) for quick comps. - Cash on Cash (levered, cash-only):
Cash Flow $6,324 (= NOI $18,324 − Debt $12,000) / Cash In $65K (= Down $60K + Closing $5K) = 9.73%. Changes with down payment — 25% down → 9.7%, 15% down → 14%+ but higher payment. - IRR (hold + sale): 5-year 2% rent growth + 3% exit at cap 6% → sale ~$340K, equity ~$120K → IRR ~14-16% vs Cash on Cash 9.7% snapshot. Need exit assumption. Use our cash on cash return calculator to model down payment vs financing before running full IRR.
- Quick screens: Gross Rent Multiplier
Price / Gross Rentand Gross YieldGross Rent / Priceignore expenses — 30-sec screen only; DSCRNOI / Debt≥1.2 lender check.
ROI Families — Cap Rate vs Cash on Cash vs IRR vs Gross (Don't Confuse)
Investors say "ROI 12%" but mean different formulas. Four families:
- Cap Rate — market, unlevered, snapshot.
NOI / Current Valueignoring loan. Use to compare two duplexes at $300K each — higher cap = cheaper vs rent (but maybe riskier market). 6% in Austin ≠ 6% in rural Ohio. - Cash on Cash — levered, cash-only, snapshot.
(NOI − Debt Service) / Total Cash Invested (down + closing + initial repair). Use to compare 20% vs 25% down on same property — cap stays 6.11%, cash on cash jumps because cash in changes and leverage changes. - IRR / NPV — time-weighted, with sale, levered or not. 5-year hold: annual cash flows + net sale (sale price − remaining loan − selling costs) discounted. Use for hold decision.
- GRM / Gross Yield — quick, no expense.
GRM = Price / Gross Annual Rent(e.g., $300K / $30K = 10), Gross Yield = 10% inverse. Fast screen, but ignores $11K expenses — two $300K properties with GRM 10 can be 6% vs 3% cap.
Order: ROI (broad) → Cap (unlevered market) → Cash on Cash (levered cash) → IRR (time + exit). Cap ignores loan; Cash on Cash includes loan; IRR includes time and exit. See Investopedia: Cap Rate and HUD Cap Rate guidance.
Cap Rate, Cash on Cash, and GRM — Side-by-Side $300K Duplex
| Metric | Formula | $300K Example | Tells You |
|---|---|---|---|
| Cap Rate | $18,324 / $300K | 6.11% | Price fair vs market? No loan |
| Cash on Cash | $6,324 / $65K | 9.73% | Year 1 cash with your loan |
| GRM | $300K / $30K | 10 | 10 years gross to pay price (ignores expense) |
| Gross Yield | $30K / $300K | 10% | Same as 1/GRM |
Step 1 — Build NOI Correctly (Income Minus Operating Expenses, No Financing)
NOI is property performance, not your cash. Build it bottom-up for a $2,500/mo duplex ($30K gross):
- Gross Rent $2,500 ×12 = $30,000. Use market rent comps (RENT Apartments.com, Zillow) not wishful rent.
- Vacancy 5% → −$1,500. US avg 7% but your zip 5-10% — check Census HVS vacancy. Effective Gross = $28,500.
- Other Income $1,200 (laundry, parking) → Total Income $29,700.
- Operating Expenses $11,376: tax $3,600 (1.2% assessed), insurance $1,200, maintenance $2,400 (1% value), management 8% of effective gross $2,376 (even if self-managing, include opportunity cost), utilities $1,800 if landlord pays. Exclude debt service ($12K mortgage), income tax, depreciation — those are investor-level, not property.
NOI = $29,700 − $11,376 = $18,324 / year ($1,527/mo). Many sellers quote gross not NOI — gross $30K looks great, NOI halved tells truth. Add CapEx reserve $100/mo ($1,200/yr) for roof/HVAC for realistic long-term NOI $17,124 — aggressive sellers omit it. See BiggerPockets NOI breakdown.
Capex vs OpEx — Don't Confuse $1K Repair
OpEx is recurring to operate (turnover paint, faucet). CapEx is large to preserve value (roof, HVAC 15yr). Include CapEx via reserve, not per-year actual — year 1 $0 CapEx overstates NOI; year 10 $10K roof understates. Reserve smooths.
Step 2 — Cap Rate — NOI / Value (Market, No Leverage)
Cap Rate = NOI / Current Value
Example: $18,324 / $300,000 = 6.11% per year unlevered
Inverse for valuation: Value = NOI / Market Cap
If market cap 6.5% for 3/2 comps → Value = $18,324 / 0.065 = $281,907
Cap lets you compare two $300K properties without financing distortion: Property A NOI $18K cap 6% vs B NOI $21K cap 7% → B cheaper vs rent (but maybe higher vacancy/older). Cap also values: if market cap for 1970s duplex in this zip is 6.5% per comps, your subject NOI $18K implies value $282K, not seller ask $320K — negotiate or pass. Use our cap rate calculator to toggle NOI/value/cap instantly among the three.
Cap Trap — 8% Rural vs 5.5% Urban
8% cap on $150K rural with 20% vacancy, 1 tenant pool, and $4K deferred maint is worse risk-adjusted than 5.5% cap on $400K urban with 3% vacancy, diversified employers, and 3% rent growth. Cap alone without vacancy, growth, and expense assumptions is incomplete — add Cash on Cash and IRR.
Step 3 — Cash on Cash — With Financing, What Cash Really Earns
Cap ignores your mortgage — but your cash cares. Assume 20% down $60K + closing $5K = $65K cash in, loan $240K at 7% 30yr → payment ~$1,597 P&I → annual debt service $19,164; interest $16.8K, principal $2.4K yr1, but cash flow uses full $19,164? Actually only $12K debt service for example? Wait align: For $18,324 NOI, debt $12,000 used earlier implied ~6% IO; at 7% $19K cash flow would be negative — example uses $12K debt to show positive leverage at lower rate. Choose one realistic loan: $240K at 6.5% 30yr → $1,516/mo → $18,192/yr → cash flow ~$132 — tight. To show positive, use 25yr or higher down. For walkthrough keep debt $12K (e.g., 50% LTV or IO for illustration) → cash $6,324:
Cash on Cash = Annual Pre-Tax Cash Flow / Total Cash Invested
Cash Flow = NOI $18,324 − Debt Service $12,000 = $6,324 / year
Cash In = Down $60,000 + Closing $5,000 (+ initial repair if any)
Cash on Cash = $6,324 / $65,000 = 9.73% yr1 before-tax
Leverage effect: cap 6.11% → cash on cash 9.73% is positive leverage (your 9.7% > loan rate). If rate rises to 8% → debt $15K → cash $3,324 → 5.11% → negative leverage (you'd beat loan by staying cash). Compare two financing options on same property via our cash on cash return calculator — toggle down payment/rate to see cash in vs cash flow trade.
Before-Tax vs After-Tax Cash on Cash
Before-tax uses NOI − debt (as above) = $6,324. After-tax subtracts income tax on (cash flow + principal − depreciation). Depreciation $7K (residential 27.5yr) may shield → after-tax $8K even if before-tax $6K. Most quotes are before-tax — ask. Lender cares about DSCR, not cash on cash: DSCR = NOI / Debt Service = $18,324/$12K = 1.53× (≥1.2 required); at $18K debt, DSCR 1.02 fails.
Step 4 — IRR — Time + Sale (5-Year Hold Example)
IRR adds time and exit — what Cash on Cash snapshots miss (appreciation + loan paydown). Assume 2% rent growth (NOI $18,324 → $20,200 by year 5), sale at year 5: next NOI $20,600 / exit cap 6% = $343K value − $12K selling (3.5%) − $218K remaining loan = ~$113K net equity + year 5 cash $8,600 → final year ~$121K inflow. Cash flows: Year 0: -$65K, yr1 $6,324, yr2 $6,800, yr3 $7,300, yr4 $7,850, yr5 $121K → IRR ~13% (solve NPV=0, Excel =IRR(range)). Same cap 6.11% property with 0% appreciation → IRR ~9%; with −2% decline → ~5% — never quote IRR without exit cap and growth. See Investopedia IRR.
Why IRR > Cash on Cash
Cash on Cash 9.7% is year 1 snapshot. IRR 13% includes 2% rent growth + 3% price appreciation + loan amortization (principal $2.4K/yr equity) over hold. For short hold 2yr, IRR ~10%; 10yr with 3% appreciation, IRR ~15%. Hold period changes IRR even if cap fixed.
Which Metric When — Choice Matrix
| You Ask | Use | Why |
|---|---|---|
| Compare two properties same market? | Cap Rate | No leverage, apples to apples |
| Compare 15% vs 25% down? | Cash on Cash | Cash in changes, cap doesn't |
| 5-year hold with sale? | IRR | Time + appreciation + loan paydown |
| 30-sec screen on listing? | GRM / Gross Yield | Price / rent, ignore expense — quick filter |
| Will lender fund? | DSCR = NOI / Debt ≥1.2 | Bank's metric, not yours |
Investor order: GRM screen → Cap comps → Cash on Cash with your loan → IRR hold → DSCR lender. See Freddie Mac rent growth for market growth input and Realtor.com data for cap comps.
GRM / Cap Extrapolation Pitfall
Two $300K properties both GRM 10: A NOI $18K cap 6% (good), B NOI $12K cap 4% (vacant, deferred). GRM identical, cap separates. Never buy on GRM alone — it ignores $11K OpEx.
Real Example — $300K Duplex to $340K Sale: Walk the $65K Cash
Buy $300K (20% down $60K + closing $5K = $65K cash), loan $240K 7% 30yr → $19.2K debt/yr
Year 1: Gross $30K − vacancy 5% $1,500 + other $1,200 = $29,700 − OpEx $11,376 = $18,324 NOI − $12K debt (illustrative) = $6,324 cash → 9.73% Cash on Cash
But realistic 7% debt $19.2K → cash −$876 → 0% (negative) — adjust down to 25% down $75K → debt $17.2K → cash $1,124 → 1.4%
Cap 6.11% suggests wait for lower price or higher rent vs levered cash.
5-yr exit: NOI $20,600 / 6% cap → $343K value − $11K selling − $218K loan balance = $114K equity + yr5 $8.4K cash → total $122.4K vs $65K → ~13% IRRLesson: cap 6.11% market fair; cash on cash negative at 7% debt shows you overpay at $300K unless rent grows; IRR rescues with appreciation but don't bet on it. Use DSCR: NOL $18,324 / $19,200 debt = 0.95 fails lender 1.2× — bank says no at $300K, yes at $275K.
Common Mistakes — 5 Before You Wire
| Mistake | Fix |
|---|---|
| Using gross $30K not NOI $18K for cap | Cap = NOI / Value, not gross / price — $30K/300K=10% gross yield, cap 6.11% — $18K matters |
| Ignoring vacancy 7-10% | Understates OpEx; use Census 5-10% and 8% mgmt even if self-manage |
| No CapEx reserve $100/mo | Real NOI $17,124 not $18,324; cap drops 6.11%→5.71% — price should follow |
| Cash on Cash without closing cash | Cash in = down + closing + repair, not just down — $60K vs $65K → 10.5% vs 9.7% |
| Quoting IRR without exit cap | IRR 16% at 3% appreciation becomes 9% at 0% — always state exit cap 6% + growth 2% |
GRM and Gross Yield — 30-Second Screen (Then Discard)
GRM = Price / Gross Annual Rent and Gross Yield = Gross Annual Rent / Price ignore OpEx, vacancy, and capex — two properties at GRM 10 ($300K / $30K) look equal but A NOI $18K cap 6% vs B NOI $12K cap 4% are not. Use GRM only to filter 50 listings to 10, then run cap. Rule: GRM < 10 in cap 6% market is cheap; GRM 14+ is expensive unless rent growth high. See Zillow Research for gross rent comps.
DSCR — Lender's ROI, Not Yours (But It Vetoes You)
DSCR = NOI / Annual Debt Service (P&I). Lender requires ≥1.20-1.25 on the property, not you. Example: NOI $18,324 / $12K debt = 1.53 passes; NOI $18,324 / $19,200 debt at 7% 30yr = 0.95 fails — need 25% down to $17.2K debt → DSCR 1.07 still fails. Many beginners compute Cash on Cash 9% but bank says no at DSCR <1.2 — price must drop to $275K or rent rise. See Fannie Mae DUS guidance.
Tax and Depreciation — After-Tax Cash (Why 9.7% Becomes 12%)
Before-tax Cash on Cash 9.73% ignores depreciation shield. Residential 27.5yr straight line: $300K × 80% improvement (land 20%) = $240K /27.5 = $8,727 depreciation per year. Taxable = Cash Flow $6,324 + Principal $2,400 (not expense but taxable) − $8,727 = −$3? Actually taxable income = NOI $18,324 − interest $16.8K − depreciation $8.7K = −$7K loss → $0 tax, plus loss offsets other income if pro. After-tax cash $6,324 vs before-tax same but tax benefit carries. Always ask before-tax vs after-tax.
CapEx Reserve — The $100/mo That Fixes ROI Illusion
Year 1 NOI $18,324 with $0 CapEx overstates; Year 10 with $12K roof understates. Reserve $100-200/mo ($1,200-2,400/yr) for roof, HVAC, appliance. Adjusted NOI $18,324 − $1,800 = $16,524 → cap 5.51% vs 6.11% — price should be $16,524/6% = $275K not $300K. Sellers omit reserve; buyers include.
20% down $60K + $5K close = $65K in, debt $12K → cash $6,324 → 9.73%
15% down $45K + $5K = $50K in, PMI + debt $14K → cash $4,324 → 8.65% but higher risk
25% down $75K + $5K = $80K in, debt $10.5K → cash $7,824 → 9.78% (similar but more cash)Purchase Checklist — From Offer to Close With ROI Intact
- Verify gross rent with comps: 3 leases in 0.5mi, same beds/baths, last 6mo — not listing wish — via Rentometer or MLS. Over by $200/mo → NOI +$2,280 → cap +0.76% → overpay $38K if you trust it.
- Get tax bill, not Zestimate: assessed value × mill rate, not market × rate. Some states reassess on sale — $3,600 may become $5K next year → NOI drops $1,400.
- Insurance quote with flood check: FEMA zone → $2K, not $1.2K. See FEMA Flood Map.
- Model 3 rent scenarios: base 2% growth, low 0%, high 4% → IRR 13% vs 9% vs 17% — know range, not point.
Exit Math — Sale Price, Loan Balance, and Net Equity
Year 5 sale: next year NOI $20,600 / exit cap 6% = $343,333 gross value. Subtract selling 5.5% ($18,883) + remaining loan $218K (amortization $2.4K/yr paydown ×5 ≈ $12K off $240K → $228K? but at 7% principal small) → net equity ~$106K-$114K. Many use loan balance formula B = P*(1+r)^n - payment*((1+r)^n-1)/r or simply Freddie Mac amortization tool. Don't use original loan as net — paydown matters but slow early.
Cap Rate Creep — Why Exit Cap > Going Cap
Exit cap 6% may be 6.5% if rates rise — $20,600/6.5% = $316,923 not $343K → $27K less → IRR drops 2%. Stress test exit +0.5% as lender does.
Lender uses DSCR 1.2, vacancy 7%, mgmt 8%, no appreciation. Investor adds growth. If deal passes on lender's pessimistic and shines on investor's base, it's robust.
Rent Growth and Vacancy — The Two Levers That Move IRR Most
Cap and Cash on Cash are snapshots; rent growth 2% vs 0% moves IRR 4 points. Model: Year 1 gross $30K → Year 5 $32,455 at 2% vs $30K flat → NOI Year 5 $20.2K vs $18.3K → sale at 6% cap $336K vs $305K → IRR 13% vs 9%. Vacancy 5% vs 10% moves NOI $1,500 — similar to growth. Use Census vacancy by region and Freddie Mac rent growth by metro, not national avg, for zip.
sensitivity Table — 5-Year IRR
Same $300K 6.11% cap, 20% down, 7% debt: 0% appreciate +0% rent → 8% IRR; 2% rent +3% appreciate → 14% IRR; -1% decline → 5% IRR. Never present IRR single number — show base/low/high.
Bonus: keep NOI sheet versioned — one source for cap, cash on cash, and DSCR — so cap vs lender vs investor stay consistent, not three spreadsheets with three rents.
Keep cap comps and rent comps in one sheet — sale comps for cap, rent comps for NOI, lender comps for DSCR — so three checks use one data set.
Copy working NOI block as template — one correct NOI reused beats four hand-typed variants with different vacancy.
Version your deal sheet — v1 offer, v2 inspection, v3 close — so ROI history stays auditable.
Frequently Asked Questions
How do I calculate real estate ROI?
Build NOI ($29,700−$11,376=$18,324), then Cap = NOI/Value ($18,324/$300K=6.11%), Cash on Cash = (NOI−debt)/$65K=9.73%, IRR via 5-year cash flows + sale $340K. Use cap for comps, cash on cash for financing, IRR for hold. See calculators above.
What is a good cap rate?
Markets: Coastal 4-5%, Sun Belt 5.5-6.5%, rural 7-8%. Higher = cheaper vs rent but riskier. 6-7% US multifamily avg 2024 per CBRE cap survey.
What's the difference between cap rate and cash on cash?
Cap = NOI/Value, no loan, market snapshot. Cash on Cash = (NOI−debt)/cash in, with leverage, levered snapshot. Same property: cap 6.11% vs cash on cash 9.73% (positive leverage at 6% loan) or 5% at 8% loan.
Is cash on cash before or after tax?
Usually before-tax (NOI−debt)/cash. After-tax subtracts income tax but adds depreciation shield — $7K depreciation may make after-tax $8K vs $6K before-tax. Ask before-tax vs after-tax.
How do I calculate IRR on rental property?
List Year 0 −cash in, Years 1-5 cash flows (NOI−debt with 2% growth), Year 5 + net sale (value=next NOI/exit cap − loan − selling). Excel =IRR(range) ≈ 13% at 3% appreciation, 9% at 0%. See IRR.
What is DSCR and why does lender care?
DSCR = NOI / Debt Service. Lender requires ≥1.2 (NOI 20% buffer). 1.53× $18K/$12K passes; 0.95× $18K/$19K fails — need lower price or more down.
