Capitalization (Cap) Rate: The Unleveraged Metric
The [Cap Rate](/tools/coc-yield/cap-rate-vs-coc-yield) evaluates a property's return on investment *assuming the asset is purchased entirely in cash* (zero debt). It is primarily used to evaluate the market value and risk premium of the asset relative to other properties in the area.
\[ \text{Cap Rate} = \frac{\text{Net Operating Income (NOI)}}{\text{Purchase Price}} \times 100 \]
A low [cap rate](/tools/coc-yield/cap-rate-vs-coc-yield) (e.g., 4%) indicates a safe, highly desirable market (like prime NYC retail). A high cap rate (e.g., 10%) indicates higher risk or less desirable locations.
Cash-on-Cash Yield: The Leveraged Metric
CoC yield evaluates a leveraged return. It fluctuates based on your financing structure: the loan interest rate, the loan-to-value (LTV) ratio, and your out-of-pocket costs.
Leveraged Arbitrage (Positive Leverage)
The magic of commercial real estate occurs through positive leverage. When the [Cap Rate](/tools/coc-yield/cap-rate-vs-coc-yield) of a property is higher than the interest rate of the bank loan used to buy it, adding debt *increases* your CoC yield.
For example, buying a property at an 8% [Cap Rate](/tools/coc-yield/cap-rate-vs-coc-yield) using a mortgage with a 5% interest rate creates a 3% spread. The bank is financing your asset cheaper than the asset yields, rocketing your Cash-on-Cash return into the double digits.