In commercial real estate investing, two terms tend to dominate conversations and decision-making: cap rate and cash flow. Both play a major role in evaluating potential deals, but they represent different aspects of a property’s performance.
In today’s evolving economic environment – with rising interest rates, tighter lending, and shifting tenant dynamics, understanding the distinction between cap rate and cash flow is more important than ever.
What Is Cap Rate?
Cap rate, short for capitalization rate, is a tool that helps investors estimate how much income a property generates in relation to its price. Think of it as a high-level snapshot of potential returns. Cap rates are often used to compare properties quickly. For example, you might hear a broker say a property is trading at a “6 cap,” which means the expected return is 6% based on the property’s income, not considering financing or other variables. They’re also useful in spotting trends, like how investor appetite or perceived risk is changing in a specific location or asset class.
But the thing is, cap rate doesn’t show you what you’ll actually take home after paying your mortgage, maintenance costs, or unexpected expenses.
What Is Cash Flow?
Cash flow is much more straightforward: it’s the actual money an investor receives after all bills are paid; mortgage included. It’s the “real-world” metric that reflects whether a property is profitable on a monthly or annual basis.
For most private investors, cash flow is a critical consideration. Whether you’re using real estate to generate retirement income, reinvesting profits into new deals, or simply trying to build financial freedom, positive cash flow is what keeps the wheels turning.
Cash flow can also serve as a buffer during market downturns, tenant turnover, or interest rate spikes. When times get tough, having a steady income from a property can make all the difference between riding out a storm or being forced to sell. Cash flow sets the return on your actual cash invested in the deal, and anything that increases the cash flow will generally increase the value of your property.
The Shift in Today’s Market
For years, cap rates have been the go-to metric for evaluating investment properties. Why? Because borrowing costs were low, and spreads between cap rates and loan interest rates left plenty of room for healthy returns – even if cash flow wasn’t immediate.
But now, with interest rates higher and operating costs rising, that dynamic has changed. Many investors are discovering that cap rate alone doesn’t tell the full story. A property may look good on paper with a decent cap rate, but if the loan payments and other expenses eat up all the income, the real return can fall flat.
When Should You Focus on Cap Rate?
Cap rate still plays an important role in a few key scenarios:
- Comparing properties in different markets
If you’re evaluating properties across regions or asset types, cap rate offers a common language. - All-cash purchases
Investors who aren’t using financing often care more about return on investment than monthly income. - Long-term value
Cap rate can provide insight into how an asset might appreciate, especially in stable, low-risk markets. - Portfolio-level decisions
Institutions and fund managers often use cap rates to balance their asset mix across risk profiles.
When Should You Prioritize Cash Flow?
In many cases today, cash flow deserves top billing, particularly for:
- Private or individual investors
If you’re relying on real estate income to support your lifestyle or grow your portfolio, cash flow is everything. - Leveraged deals
When you’re using a loan to acquire a property, your take-home income depends on what’s left after debt payments. - Shorter-term strategies
Investors aiming to flip or reposition properties within a few years need cash flow to support operations until disposition. - Economic uncertainty
When inflation, vacancies, or rate hikes create instability, predictable cash flow offers a much-needed safety net.
Finding the Right Balance
At the end of the day, smart investors recognize that both cap rate and cash flow have value, but they serve different purposes. Cap rate helps you understand the market and the asset’s position within it. Cash flow helps you understand whether the investment can support your financial goals and sustain itself over time.
If you’re trying to decide between the two, ask yourself:
“Am I buying based on future appreciation, or am I counting on monthly income?”
That simple question can clarify your investment approach and help guide your next acquisition.
Let the ICRE Investment Team Help You Decide
Navigating cap rates and cash flow is more than a numbers game; it’s about strategy, timing, and knowing how to position your capital in today’s market.
At the ICRE Investment Team, we specialize in helping investors make informed, data-driven decisions with real-world implications. Whether you’re evaluating a medical office property in Gilbert, an office condo in Midtown Phoenix, or a value-added retail center in a growing suburb, we’ll help you weigh the factors that matter most. Contact us for a custom property evaluation.
