Why One Number Is Not Enough
A rental can look great on one measure and poor on another. The price may be low compared with the rent, but the mortgage payment, taxes, insurance, repairs, vacancies and management can take most of the income. To judge a property you need to see the whole chain: income, expenses, financing and the cash you put in.
This guide walks through that chain with one worked example, so every number is traceable. You can replace the example with your own property in the calculator.
👉 Analyze a rental property with our free ROI calculator →
The Example Property
- Purchase price $280,000, rent $2,400 a month plus $50 of other income (parking, pet fees)
- 20% down ($56,000), $5,000 of repairs, 3% closing costs ($8,400), so $69,400 of cash is invested
- Mortgage 6.75% for 30 years on $224,000, a payment of $1,453 a month
- Vacancy 5%, property tax 1.2% of the price, insurance $1,400 a year, maintenance 8% and management 8% of rent collected
Step 1: Net Operating Income (NOI)
NOI is what the property earns before any mortgage payment:
| Item | Per Year |
|---|---|
| Gross rent and other income ($2,450 × 12) | $29,400 |
| Vacancy (5%) | −$1,470 |
| Income collected | $27,930 |
| Property tax | −$3,360 |
| Insurance | −$1,400 |
| Maintenance (8%) | −$2,234 |
| Property management (8%) | −$2,234 |
| Net operating income | $18,701 |
Operating expenses take about 33% of income. That is far above the "I only pay the mortgage" mental math many first-time landlords start with.
Step 2: Cap Rate
Cap rate = NOI ÷ purchase price: $18,701 ÷ $280,000 = 6.68%.
The cap rate describes the property as if you paid all cash. It does not depend on your loan, so it is the best way to compare one property with another. Higher cap rates mean more income per dollar of price, usually in exchange for more risk, older buildings or weaker locations.
Step 3: Cash Flow and Cash-on-Cash Return
Cash flow = NOI − mortgage payments: $18,701 − ($1,453 × 12 = $17,434) = $1,267 a year, or $106 a month.
Cash-on-cash return = yearly cash flow ÷ cash invested: $1,267 ÷ $69,400 = 1.83%.
This is the return on the money you put in, and it is much lower than the cap rate because the mortgage costs nearly as much as the property earns.
Why Debt Can Lower Your Return
Using a mortgage is supposed to boost returns, but only when the property earns more than the loan costs. Compare the example financed and bought with all cash:
| How You Pay | Cash Invested | Monthly Cash Flow | Cash-on-Cash Return |
|---|---|---|---|
| 20% down, 6.75% mortgage | $69,400 | $106 | 1.83% |
| 25% down, 6.75% mortgage | $83,400 | $196 | 2.83% |
| All cash | $293,400 | $1,558 | 6.37% |
Swipe sideways to see all columns. The all-cash buyer earns 6.37% because there is no loan payment, but needs $293,400. The mortgage rate (6.75%) is slightly above the cap rate (6.68%), so each borrowed dollar earns less than it costs and leverage lowers the return. Debt helps only when the cap rate is above the mortgage rate.
What Moves the Result Most
Rent
Rent drives everything. With the same costs:
| Monthly Rent | Cap Rate | Monthly Cash Flow | Cash-on-Cash Return | 1% Rule |
|---|---|---|---|---|
| $2,000 | 5.31% | −$214 | −3.69% | fails (0.71%) |
| $2,400 | 6.68% | $106 | 1.83% | close (0.86%) |
| $2,800 | 8.05% | $425 | 7.34% | passes (1.00%) |
| $3,200 | 9.41% | $744 | 12.86% | passes (1.14%) |
An extra $400 of rent turns a barely positive property into a solid one, while $400 less makes it lose money every month.
Interest rate
At the base rent of $2,400, only the mortgage rate changes:
| Mortgage Rate | Payment (P&I) | Monthly Cash Flow | Cash-on-Cash Return |
|---|---|---|---|
| 5.75% | $1,307 | $251 | 4.34% |
| 6.75% | $1,453 | $106 | 1.83% |
| 7.75% | $1,605 | −$46 | −0.80% |
Vacancy and management
Doubling vacancy from 5% to 10% cuts monthly cash flow from $106 to $3, and the cap rate to 6.24%. Managing the property yourself (no 8% fee) lifts it to $292 a month, but you are paying with your time, which is not free.
The 1% Rule and the Gross Rent Multiplier
Two quick screens help you discard poor deals before doing the full analysis:
- The 1% rule: monthly rent should be at least about 1% of the purchase price. The example earns 0.86% ($2,400 on $280,000), so it falls short. It is a rough filter, not a verdict, and it is harder to meet in expensive markets.
- Gross rent multiplier (GRM): price ÷ yearly gross rent. The example is $280,000 ÷ $29,400 = 9.52. Lower is better, and it is only useful for comparing similar properties in the same area.
What the Ratios Leave Out
- Appreciation. Rising property values add to your total return but are not cash flow, and they are not guaranteed.
- Principal paydown. Each mortgage payment also builds equity, which cash-on-cash return does not count.
- Taxes. Rental income is taxable, but you can deduct expenses and depreciate the building over 27.5 years for residential property, which often reduces what you owe. Ask a tax professional how it applies to you.
- Big repairs. A new roof or HVAC is not in an 8% maintenance allowance. Keep a reserve.
- Selling costs. Agent commissions and closing costs reduce what you net when you sell.
Frequently Asked Questions
What is a good cap rate?
There is no universal number. Cap rates vary by market and property type, and a higher one usually means more risk. Compare it with the mortgage rate and with similar properties nearby rather than aiming for a fixed figure.
What is a good cash-on-cash return?
Many investors look for something in the high single digits or above, because the property takes work and carries risk. Your own target should be above what you could earn with less effort, for example in an index fund.
Does a higher down payment improve returns?
It improves monthly cash flow, since the loan is smaller, but it also raises the cash you invest. In the example, going from 20% to 25% down lifts cash-on-cash return from 1.83% to 2.83%, because the loan costs more than the property earns.
Should I include appreciation in my ROI?
Treat it as a bonus, not as the plan. A deal that only works if prices rise is a bet. Make sure cash flow holds up with conservative assumptions.
How much should I budget for maintenance and vacancy?
Common planning figures are 5% to 10% of rent for vacancy and 5% to 10% for maintenance, but older properties and some markets need more. The calculator lets you set both.
Conclusion & Recommended Next Steps
Start with the cap rate to compare properties, then use cash flow and cash-on-cash return to see what you actually keep, and test how the result changes if rent drops, vacancy rises or rates are higher. If the deal only works under optimistic numbers, move on. When you are comparing a rental with buying your own home, also read our guide on rent vs. buy, and see how much you can borrow in how much house you can afford on a $75,000 salary.
Rental Property ROI Calculator
Get cap rate, cash flow, cash-on-cash return and more.
Mortgage Payment Calculator
Check the payment on an investment property loan.
ROI Calculator
Measure the total return on any investment.
Mortgage Refinance Calculator
See if refinancing a rental improves your cash flow.
Disclaimer: This guide is intended solely for educational and informational purposes and does not constitute personalized financial, investment, legal, or tax advice. Rents, expenses, vacancy, financing terms and tax treatment vary by property and location, and the figures above are illustrations based on the stated assumptions. Consult a qualified professional before buying an investment property.