Capitalization (Cap) Rate
Cap rate evaluates a property's unleveraged return on investment. It assumes the asset is purchased entirely in cash. It is used to compare property values across different markets:
\[ \text{Cap Rate} = \frac{\text{Net Operating Income (NOI)}}{\text{Purchase Price}} \times 100 \]
Cash-on-Cash Yield
CoC yield evaluates a leveraged return. It changes based on the loan interest rate, loan-to-value (LTV) ratio, and closing costs. CoC yield tells an investor their actual cash flow velocity relative to their cash outlay.
Leveraged Arbitrage
When the Cap Rate is higher than the borrowing interest rate, adding debt increases the CoC yield. This is called **positive leverage** or leveraged arbitrage.