Risk Premium

A risk premium is the return an investment offers above a risk-free alternative, compensating the investor for uncertainty. Measuring a rental's cash on cash return against a Treasury or savings yield shows how much premium you are paid for vacancies, repairs, tenants and illiquidity.

If a Treasury bond pays 4%, a rental paying 6.3% cash on cash offers a 2.3 point premium in year one. Appreciation and loan paydown add to that over time, which is part of why investors accept a thin first-year margin.

A thin premium is still a warning sign. Rent can fall, expenses can jump and a property cannot be sold in a day. Many investors set a minimum cash on cash target a few points above safe yields for exactly this reason, and raise it for older buildings or weaker markets.

Further reading: Risk Premium on Wikipedia.