Cash-on-cash return is the cash a rental puts in your pocket in a year, divided by the cash you took out of your pocket to buy it. It is measured before income taxes and, unlike cap rate, it includes the effect of your loan.
Cash-on-cash return = annual pre-tax cash flow ÷ total cash invested
You buy a $200,000 rental with $40,000 down, $6,000 in closing costs and $4,000 in upfront repairs, so total cash invested is $50,000. The property's net operating income is $16,500 a year and loan payments are $1,000 a month, or $12,000 a year. Annual cash flow is $16,500 minus $12,000, or $4,500. Cash-on-cash return is $4,500 ÷ $50,000 = 9%.
A common mistake is dividing by the down payment alone. Leave out closing costs and repairs here and the return looks like $4,500 ÷ $40,000 = 11.25%, which overstates it. Also remember what the number does not count: loan paydown, appreciation and income taxes. It is a one-year snapshot of spendable cash, so use realistic vacancy and repair figures when you estimate cash flow. A small change in rent or expenses moves it quickly because a fixed loan payment stays the same.