What’s the difference between ROI and CAP Rate?

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One of our newer forum members recently asked:

“What’s the difference between ROI and CAP Rate?”

Thanks to one of our resident experts, Ryan Webber, he got a perfect answer:

ROI is your return on investment factoring in your financing. Its your annual cash flow after all expenses divided by your initial investment (out of pocket expense). ROI depicts the true percentage that you will make on your money in the first year. Capitalization rate (cap rate) is your ROI if you paid cash for the property. It doesn’t include financing. It is a better way to compare apples to apples and take financing differences out of the picture. Cap rate is factored by taking your annual Net Operating Income (NOI), which is your gross income minus all expenses except debt service (principal and interest mortgage payment), and dividing that by the purchase price of the house.

Again, Cap Rate is the percentage you would make on your money if you paid cash for the property, and ROI is what your actual percentage is when you factor financing into it.

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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.