In more detail
Net operating income (NOI) is rent actually collected minus operating costs such as property tax, insurance, repairs, management and an allowance for vacancy, but before mortgage payments and income tax. Leaving financing out makes the cap rate a property-level yield you can compare across buildings, however each buyer pays for them. Turned around, value = NOI / cap rate is how investors price income property. Cash-on-cash return instead compares the yearly cash flow after loan payments with the cash you invested.
Why it matters
A cap rate below your mortgage rate means borrowing lowers your return rather than raising it. Sellers' figures often leave out vacancy or maintenance, which inflates the NOI and therefore the cap rate.
Example
A $250,000 property rents for $2,000 a month ($24,000 a year). After a 5% vacancy allowance ($1,200) and $6,800 of operating costs, NOI is $16,000, a cap rate of 6.4%. Buying it with $62,500 down and a $187,500 loan at 7% over 30 years costs $14,969.31 a year in payments, leaving $1,030.69 of cash flow: a cash-on-cash return of only 1.65% (before closing costs).