A 6.2% cap rate and a 7.5% mortgage cannot both be paid from the same rent
Rent of $2,200 less $650 of operating costs leaves $1,550 a month before debt. The mortgage on $240,000 at 7.5% over thirty years takes $1,678. The property therefore runs $128 a month short — about $1,537 a year out of your pocket — and the cash-on-cash return is negative 2.56%.
This is not a quirk of the defaults; it is the arithmetic of borrowing at a rate above the asset’s unlevered yield. The building earns 6.2% on its price. The debt costs 7.5%. Leverage multiplies the gap in whichever direction it points, so borrowing against a 6.2% asset at 7.5% converts a modest positive return into a monthly loss. Change the mortgage rate to 5.5% and the same property turns cash-flow positive without a single change to the rent.
The building yields 6.2% however you buy it; your cash returns −2.56% because of how you did
Cap rate divides net operating income by the purchase price, ignoring the loan entirely. Cash-on-cash divides the actual annual cash flow by the actual cash you put in — here $60,000 of deposit. Move the down payment to 40% and the cap rate does not budge, while cash-on-cash improves sharply because less of the rent is going to interest.
Use them together. The cap rate tells you whether the asset is fairly priced against other buildings. The cash-on-cash tells you what this particular structure does to your own money. A good building bought with bad financing and a mediocre building bought with cheap financing can look identical on one measure and completely different on the other.
$650 a month on a $300,000 property is 30% of rent, and many properties need more
Operating expenses here must cover everything except the mortgage: property tax, insurance, maintenance, management if you use it, and a vacancy allowance. The default of $650 is 29.5% of gross rent. Real figures commonly land between 35% and 50% once a management fee and honest maintenance reserves are included, and understating this line is the single most common way a rental model flatters a deal.
Two costs are routinely forgotten. Vacancy is not zero — even a well-run single-family rental turns over, and a month empty each year is 8.3% of annual rent. Capital expenditure is lumpy but certain: roofs, boilers and appliances all fail eventually, and setting aside a few hundred dollars a month against them is the difference between a plan and a surprise.
Principal paid down and price growth do not appear in the monthly figure at all
The $128 monthly shortfall is only the cash side of the return. Each mortgage payment also retires principal — early in a thirty-year loan that is modest, but it is equity you own rather than money spent — and the property may appreciate. A deal that is slightly cash-flow negative can still build wealth through those two channels, which is how many long-held rentals actually pay off.
The risk is using that as a blanket excuse. Appreciation is a forecast, not an input, and a property that costs you money every month requires you to keep feeding it through vacancies, repairs and rate resets. Negative cash flow is survivable when it is small, deliberate and funded from elsewhere; it is how portfolios fail when it is none of those things.
No closing costs, no taxes, no rent growth, and a fixed rate for thirty years
The purchase price excludes closing costs, which typically add 2–5%, and any renovation needed before the first tenant. Neither the rent nor the expenses grow with inflation here, so a long-run projection built on these figures will understate both. Income tax, depreciation deductions and the eventual capital-gains treatment are all outside the calculation, and for a US investor depreciation in particular can change the after-tax picture materially.
The financing is assumed fixed for the full term. An adjustable rate, an interest-only period, or a balloon at year five would each change the payment and therefore every figure that depends on it. Treat the output as a clean comparison between properties under identical assumptions rather than a forecast of what one property will do.
Frequently Asked Questions
What is a good cap rate?
A good cap rate depends on the market: 4–5% in expensive coastal markets, 6–8% in mid-tier markets, 8–12% in affordable markets. Higher cap rates compensate for lower appreciation prospects.
What expenses should I include?
Property taxes, insurance, HOA fees, maintenance (budget 1% of purchase price/year), property management (8–10% of rent), vacancy (5–10%), and capital expenditure reserves.
What is the difference between cash flow and cash-on-cash return?
Cash flow is the dollars left each month after the mortgage and operating expenses are paid. Cash-on-cash return expresses your annual cash flow as a percentage of the actual cash you invested, mainly the down payment. Two deals can have similar monthly cash flow but very different cash-on-cash returns if one required a much larger down payment.
Why might a negative-cash-flow property still attract investors?
Some investors accept a small monthly loss because they expect the property to appreciate, because tenants are paying down the loan and building their equity, or because depreciation provides tax benefits. That is a bet on future gains rather than current income, and it carries more risk — if appreciation does not materialize, you are funding the shortfall out of pocket every month.
Should the mortgage be part of operating expenses?
No. Operating expenses cover the cost of running the property — taxes, insurance, maintenance, management, vacancy. The mortgage is a financing cost, so it is excluded from net operating income and the cap rate, but it is very much included when calculating actual cash flow, because it is real money leaving your account each month.
How should I budget for vacancy and repairs?
Build them into your monthly expenses rather than assuming full occupancy and no surprises. A common starting point is to reserve several percent of rent for vacancy and roughly one percent of the property value per year for maintenance and capital expenditures. Underbudgeting these is one of the fastest ways a deal that looked profitable turns into a money loser.
Sources & References
Figures on this page are checked against primary, authoritative sources. Links open in a new tab.
Returns are assumptions, not guarantees. Actual results may vary because of market performance, taxes, fees, inflation, and timing. This is an educational projection, not investment advice.
Published the calculator with its formula, worked example, assumptions, limitations and FAQs, and added an automated formula test suite covering it.
Cross-checked the cap rate against the standalone Cap Rate Calculator on the same building, and confirmed the cap rate stays unlevered while cash-on-cash responds to the financing.
Frequently Asked Questions now show on the page: 6 answers, checked in a page-by-page audit.
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