Cash Flow vs Cap Rate
Two numbers that get mixed together. Here’s how I separate them when looking at a rental.
The story
A friend sent me a deal and said the cap rate was 8 percent. I asked what the monthly cash flow would be after the mortgage. He paused. The property looked strong on a cap-rate basis because it was paid for in cash in his model, but once financing was added the monthly number turned negative. That conversation made the difference clear. Cap rate tells you something about the property’s operating performance relative to price. Cash flow tells you whether money is left after the mortgage and other costs you actually pay.
Both numbers can be useful. They answer different questions. Treating them as interchangeable is where people get surprised after closing.
Known mistakes
- Quoting cap rate while ignoring the financing you will actually use.
- Calculating cash flow without a reserve for repairs or vacancy.
- Comparing cap rates across different markets without looking at risk or growth.
- Focusing only on the higher number and skipping the monthly reality.
- Using pro forma rents that have not been verified.
What I would do if I were starting over
- Calculate net operating income first: rent minus operating expenses, before any mortgage.
- Divide that by the purchase price to get a basic cap rate.
- Then run a separate cash-flow number that includes the actual mortgage payment, taxes, insurance, and reserves.
- Look at both numbers side by side. A decent cap rate with negative cash flow means the financing or price needs work.
- Ask what has to change for the monthly number to stay positive after a vacancy or repair.
- Keep the two calculations in the same place so you do not update one and forget the other.
- Review the numbers again after the inspection and after you lock in financing terms.
Cap rate helps you compare properties. Cash flow helps you decide whether you can hold the property without stress. Use both, and keep them separate.