Understanding Multifamily Returns: Cap Rates, Cash-on-Cash, and IRR

Newer multifamily investors hear three terms more than any others: cap rate, cash-on-cash return, and IRR. Each looks at performance from a different angle—pricing today’s income, measuring near-term equity yield with debt, and evaluating the full life of the investment. This guide explains what each metric means, how to use them together, and how financing can change outcomes. The examples come from Chicago multifamily properties like the ones our team underwrites every day, but the framework applies broadly.

1) Cap Rate: Pricing Today’s Income

Cap rate is simply NOI ÷ Purchase Price and is best read as an all-cash yield on current, stabilized operations. It’s a fast way to quick-check pricing across neighborhoods and vintages. Just make sure the NOI is normalized for taxes, insurance, and reasonable reserves, or the number can be misleading.

Example: A 24-unit property with a $240,000 stabilized NOI priced at $4,000,000 reflects a 6.0% cap rate.

Context matters. In Chicago, well-located, lower-risk assets often close with lower cap rates than properties that require heavier value-add. When investors ask what a good cap rate in Chicago is, the honest answer is “it depends”—on location, asset quality, and the business plan. Start with recent, like-kind comps and adjust for the specifics of the deal in front of you.

2) Cash-on-Cash Return: Year-One Equity Yield With Debt

Cash-on-cash looks at the annual pre-tax cash flow after debt service ÷ total equity invested. It connects projected performance of the property to the equity needed and expected early distributions. Loan terms like rate, amortization, and interest-only period can move this figure meaningfully, as can DSCR and occupancy.

Example (same building):

• All-cash: $240,000 ÷ $4,000,000 = 6.0%
• 75% LTV loan: $1,000,000 equity with ~$120,000 after-debt cash flow ≈ 12.0%

Cash-on-cash returns for multifamily in Chicago depend on risk and leverage: stabilized assets often pencil to single-digit yields while heavier value-add can underwrite much higher.

3) IRR: Returns Over Time

IRR is the annualized return that makes today’s value of what you put in equal to the value of everything you get back—operating cash flow, capex, and sale proceeds. It lets you compare deals with different timelines and leverage, but it’s highly sensitive to assumptions like the exit cap, rent and expense growth, and when capital is spent.

How Financing Changes Results

Debt doesn’t change the cap rate, but it directly affects cash-on-cash and, ultimately, IRR. When your going-in cap rate exceeds the all-in borrowing cost, leverage can boost equity yield; when it doesn’t, leverage can compress returns. Pay attention to DSCR, fixed vs. floating rate exposure, interest-only periods, refinance risk, and where rates might be when you need to refinance the debt. Investors often want to know how financing affects CRE returns—the impact can be substantial, so build and review sensitivities.

A Practical Three-Step Workflow

1. Price check with cap rate. Normalize NOI (taxes, insurance, reserves) and compare to recent, like-kind comps in the same sub-market and vintage.
2. Add in debt to see cash-on-cash. Test multiple LTVs and structures, confirm DSCR, and stress rates and vacancy to understand downside.
3. Compare strategies with IRR. Build conservative/base/upside cases, map capex timing realistically, and use an exit cap that’s modestly wider than entry to account for cycle risk.

Illustrative Example (Hypothetical, Chicago)

• Purchase Price: $7.2M
• Stabilized NOI: $432k → 6.0% cap
• Capital Structure: 70% loan / 30% equity
• Year-1 After-Debt Cash Flow: ≈ $151k → ~7% cash-on-cash
• Plan: $480k in renovation upgrades over years 2–3; 3% rent growth; exit in year 7 at a slightly wider cap
• Indicative Results: lower-teens IRR in a conservative case, mid-teens in base, and high-teens with clean execution

Takeaway: an average going-in cap can still work if the business plan is credible and exit risk is priced appropriately.

Common Mistakes

• Relying on a single metric: Cap rate, cash-on-cash, and IRR answer different questions; use them together.
• Aggressive Assumptions: Assume a higher exit cap rate and budget in buffers for taxes, insurance, and repairs.
• Limited reserves: Underfunded reserves overstate cap rate, cash-on-cash returns, and IRR.
• Sensitivity analysis: Run multiple scenarios on interest rates, rent increases, expenses, and exit cap rate.

How Essex Realty Group Can Help

At Essex, we underwrite each property with specific neighborhood on rents, operating costs, and taxes. We evaluate the T-12, scrub the rent roll, assess reserves and taxes, and analyze current rent and sale comps. Then we share an investor-ready packet—stabilized NOI and a cap-rate screen, an operating summary with normalization notes, comp tables, tax/insurance projections, and high-level debt ranges to illustrate the projected property returns.

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Since 1990, Essex Realty Group, LLC has served Chicago’s investment real estate market as a top multifamily brokerage firm, specializing in Chicago multifamily for sale properties. Contact us today to learn more about our recent multifamily and mixed-use property sales or click HERE.

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