How to Analyze a Rental Property: Cash Flow, Cap Rate and Cash-on-Cash Return

A rental property can look attractive on a listing sheet and still lose money every month. Three measures, used together, give a clearer picture. You can run all three in our investment analysis calculator.

Start with realistic income and expenses

Every measure depends on the inputs, so build them carefully.

• Rent: use rents for comparable homes nearby that have actually leased, not asking rents.
• Vacancy: assume some months without a tenant, especially between leases.
• Operating expenses: property taxes, insurance, maintenance and repairs, capital reserves for big items such as a roof or heating system, property management, utilities you pay, and association fees.
• Financing: your mortgage payment, if you borrow.

Net operating income (NOI)

NOI is the property's yearly income after vacancy and operating expenses, before mortgage payments. It describes the property itself, independent of how you finance it.

Cap rate

Cap rate = NOI ÷ purchase price.

Cap rate lets you compare properties regardless of financing. A higher cap rate means more income per dollar of price, but often comes with more risk or more work. It says nothing about your loan, your down payment or future appreciation.

Cash flow

Cash flow = NOI − mortgage payments.

This is what is left each month or year after the bills and the loan are paid. Positive cash flow gives you a cushion; negative cash flow means you are paying to hold the property.

Cash-on-cash return

Cash-on-cash return = yearly cash flow ÷ total cash invested.

Total cash invested includes your down payment, closing costs and any upfront repairs. This measure tells you how hard your own money is working, but it ignores loan paydown and appreciation.

Stress-test before you commit

Rerun the numbers with:

• a lower rent and a longer vacancy;
• higher repair costs, especially for an older property;
• a higher property tax bill after the sale, since a reassessment or appeal can change it;
• a higher interest rate, if your loan rate is not yet locked.

If the property only works in the best case, it is a risky purchase. If it still holds up under the tougher assumptions, you have a margin of safety.

Want a second set of eyes on a deal? Talk to us about your investment goals.