Cap rate, cash-on-cash and IRR each answer a different question

Cap rate is net operating income divided by price. It ignores financing entirely, which is exactly what makes it useful: it compares two buildings on the same footing regardless of how each buyer pays for them. It says nothing about what an individual investor earns. Cash-on-cash is annual pre-tax cash flow divided by the cash actually invested — down payment, closing costs, and the money spent getting the property rentable. It does account for the loan, which means leverage inflates it, and a high cash-on-cash on a heavily leveraged property is a statement about the debt as much as about the building. Internal rate of return folds in time and the eventual sale. It is the only one of the three that answers "what did this investment earn, annualised, over the whole hold" — and it is the most sensitive to assumptions, because the exit price usually drives most of it. An IRR built on an optimistic sale in year five is an opinion with a decimal point. None of them is wrong. Using the wrong one is. A discipline worth adopting: compute all three, and write down the two or three assumptions that move the IRR most. If a small change in the exit cap rate flips the deal from good to unacceptable, the deal is a bet on the exit, not on the building — and that is a decision worth making consciously. Equity multiple, total cash back divided by cash in, is the plain-language companion to IRR and harder to dress up. This article is general information, not legal, tax or financial advice. Rules change and every deal is different — check your own case with a licensed professional. Alberto Zaltzberg — Adonait · adonait.com