To run the numbers on a rental property, you convert the building into a small stack of financial metrics: what it earns, what it costs, what it returns on the cash you put in, and whether it can survive a bad month. The core arithmetic is simple. The discipline is in using realistic inputs and refusing to let one flattering metric carry the decision.
Start With the Raw Inputs
Every calculation downstream depends on five ingredients: purchase price, closing costs, projected rental income, operating expenses, and financing terms. Get any of these wrong and the rest of the analysis is fiction.
Closing costs on a mortgage-financed purchase run 2% to 5% of the loan amount, covering title insurance, escrow, recording, and lender origination fees.1Fannie Mae. Closing Costs Calculator If the unit needs work before a tenant can move in, get contractor bids now and treat those repairs as part of your total investment.
For income, pull comparable rents in the neighborhood for a unit of the same size and condition. Don’t rely on the seller’s projection or a listing agent’s best-case figure. Ancillary income from parking, laundry, storage, or pet fees belongs on a separate line so you can see how much of the deal depends on it.
Operating expenses need real quotes, not estimates. Pull property taxes from the county assessor rather than the seller’s disclosure. Get an actual insurance quote for a landlord policy. Property management, if you won’t self-manage, typically runs 8% to 12% of collected rent for single-family and small multifamily, and that range doesn’t include the tenant-placement fee many managers charge to fill a vacancy.
Financing terms come from your lender’s Loan Estimate, which lays out the loan amount, interest rate, term, and monthly payment.2Consumer Financial Protection Bureau. Loan Estimate Explainer If you’re still shopping, use conservative rate assumptions. A quarter-point swing can move annual cash flow by hundreds of dollars.
Build In Vacancy and Reserves
Two lines cause more bad deals than any others: vacancy and maintenance reserves. A common guideline is 5% to 10% of gross rent for routine maintenance and 5% to 8% for vacancy. Older buildings and high-turnover markets sit at the top of both ranges. Skimping here is the fastest way to turn a spreadsheet winner into a monthly drain.
Capital expenditures are a separate reserve. Maintenance covers dripping faucets. Capital expenditures cover the roof, the HVAC, the water heater, the full appliance package—the lumpy replacements that hit every property eventually. A workable rule is 10% of monthly rent set aside for capex on top of your routine maintenance reserve. At a $1,500 rent, that’s $150 a month accumulating in a dedicated account. The IRS assigns a five-year recovery period to appliances like stoves and refrigerators, and 27.5 years to the building itself.3Internal Revenue Service. Publication 527 (2025), Residential Rental Property Those aren’t perfect proxies for useful life, but they anchor the replacement cycles. A more precise reserve target divides each component’s replacement cost by its useful life.
Net Operating Income
NOI is the anchor. It tells you what the property earns from operations, independent of how you financed it.
Start with gross potential income: annual rent plus ancillary revenue. Subtract vacancy to get effective gross income. Subtract operating expenses—taxes, insurance, management, maintenance reserve, capex reserve. What’s left is NOI.
Two things stay out on purpose. Mortgage principal and interest aren’t operating expenses, because NOI is meant to describe the building, not the loan. Irregular capital improvement projects like a full roof replacement are also excluded from the annual figure, though your monthly reserve contributions toward those future costs are a legitimate operating expense.
Cash Flow After Debt Service
NOI shows what the property earns. Cash flow shows what lands in your account. Subtract annual mortgage payments (principal and interest) from NOI. Positive means the property pays for itself and puts money in your pocket. Negative means you’re feeding it every month. Negative cash flow can be a defensible bet in a strong appreciation market, but only if you knew the number before you signed.
Cash-on-Cash Return
Cash-on-cash return answers the question most investors actually care about: what percentage am I earning on the dollars I put in? Divide annual pre-tax cash flow by total cash invested.
Total cash invested is more than the down payment. It includes closing costs and any renovation you funded before the first rent check. Put $50,000 down, pay $6,000 in closing costs, spend $14,000 on pre-lease repairs, and your cash in is $70,000. If the property throws off $7,000 a year, your cash-on-cash return is 10%.
This is where you compare rental real estate to other options for the same dollars. Ten percent competes favorably against most stock dividend yields. Three percent should raise the question of why you’re taking on landlord risk for a bond-like yield. Most experienced investors want to see 8% to 12% before they get serious, though the target moves with market and strategy.
Capitalization Rate
Cap rate strips financing out entirely and shows what the property yields as if you paid cash. Divide NOI by purchase price (or current market value). A $300,000 property with $24,000 in NOI carries an 8% cap rate. The same NOI on a $400,000 property drops to 6%.
Higher cap rates mean higher yields and usually more risk: rougher neighborhoods, older buildings, higher turnover. Lower cap rates typically reflect stronger, more stable markets where appreciation carries more of the return. Comparing a property’s cap rate to a risk-free Treasury yield gives you a sense of the risk premium you’re being paid to own real estate instead of a government bond.4Federal Reserve Bank of St. Louis – FRED. Market Yield on U.S. Treasury Securities at 10-Year Constant Maturity If the spread is thin, you’re taking landlord risk for little extra return.
Quick Screens Before You Build a Spreadsheet
Two shortcuts help you decide whether a property deserves the full workup.
The Gross Rent Multiplier divides purchase price by annual gross rent. A $240,000 property renting for $24,000 a year has a GRM of 10. Lower is better because you’re paying less per dollar of income. GRM ignores expenses, which limits its use but also makes it fast.
The One Percent Rule is simpler still: monthly rent should be at least 1% of purchase price. A $200,000 property should rent for $2,000 a month. Deals that clear this bar tend to cash-flow after expenses. Deals that fall well short of it rarely survive detailed analysis. Neither screen replaces the real math. Both save time on deals that were never going to work.
Debt Service Coverage Ratio
DSCR measures whether the property earns enough to comfortably cover the loan. Divide NOI by total annual debt service (principal and interest). A DSCR of 1.0 means the property earns exactly the mortgage. A DSCR of 1.25 means it earns 25% more.
The number matters twice. Lenders use it to decide whether to approve an investment property loan and at what terms; most want a minimum between 1.0 and 1.25, with better pricing above 1.25. You should use it as a safety margin. At 1.05, a single vacancy or unexpected repair forces you to cover the mortgage out of pocket. Below 1.2 is a yellow flag for most experienced investors.
Total Return, IRR, and Equity Multiple
Cash-on-cash captures one slice of the return. The full picture also includes mortgage paydown and appreciation.
A simple total ROI takes the gain in property value plus cumulative net income and divides by initial investment. Buy a property for $220,000 with $50,000 cash in, earn $14,000 a year for five years, sell at $250,000, and the total return is $70,000 in cumulative income plus $30,000 in appreciation over $50,000 invested: 200% total, roughly 40% per year before taxes.
Appreciation is the hardest input to project honestly. Conservative underwriting assumes 0% to 2% annually and treats anything more as upside. Assuming aggressive appreciation to make a marginal deal pencil is speculation wearing analysis as a costume.
For multi-year holds, two metrics do a better job than any single-year figure.
Internal Rate of Return is the annualized compound rate that makes every cash inflow (rent, tax benefits, sale proceeds) equal every outflow (down payment, closing costs, operating shortfalls) in present-value terms. A 15% IRR means your money is compounding at 15% per year across the hold. Any spreadsheet handles the calculation. What matters is that IRR penalizes returns that arrive slowly, so early cash flow and a clean exit score better than a return concentrated in a distant sale.
The Equity Multiple is the plain-English cousin: total cash received (all cash flow plus net sale proceeds) divided by total cash in. A 2.0x multiple means you doubled your money; 1.3x means you got your capital back plus 30%. IRR ignores scale and duration; equity multiple ignores timing. Investors use them together.
How Leverage Changes the Math
Leverage is the reason rental real estate often outperforms its cash-on-cash figure over time. Put 20% down and you control 100% of the income and 100% of the appreciation on cash equal to a fraction of the property’s value. If a $300,000 property appreciates 3%, that’s $9,000 in value. On $60,000 in cash invested, your equity grew 15%, not 3%. Tenants pay the mortgage down at the same time, building equity you didn’t fund.
The downside is symmetrical. A 10% drop in value isn’t a 10% loss on your investment; it’s a 50% loss on the equity in a 20%-down deal. Negative cash flow on a leveraged property compounds quickly. Conservative inputs before you buy are the only real defense.
Tax Effects Worth Building In
Rental property generates tax benefits meaningful enough to change how it compares to other investments. Leaving them out understates the after-tax return.
Depreciation
The IRS lets you deduct the cost of a residential rental building over 27.5 years, even as the property may be appreciating in market value.3Internal Revenue Service. Publication 527 (2025), Residential Rental Property Only the building depreciates, not the land, so allocate the purchase price between the two using assessed values or an appraisal. On a $250,000 property where the building is 85% of value, the depreciable basis is $212,500, roughly $7,727 per year in deductions. Appliances, carpeting, and rental-use furniture have a five-year recovery period, which front-loads their deductions.
Passive Loss Rules
Rental income is generally passive, and passive losses normally offset only passive income. The exception: if you actively participate in managing the property—decisions on tenants, repairs, and lease terms—you can deduct up to $25,000 in rental losses against ordinary income each year.5Office of the Law Revision Counsel. 26 U.S. Code 469 – Passive Activity Losses and Credits Limited The allowance phases out between $100,000 and $150,000 of modified adjusted gross income.6Internal Revenue Service. Publication 925 (2025), Passive Activity and At-Risk Rules
Qualified Business Income Deduction
The Section 199A deduction, made permanent by the One Big Beautiful Bill Act in 2025, allows eligible landlords to deduct up to 20% of qualified business income from rental activities.7Internal Revenue Service. Qualified Business Income Deduction Qualification depends on total taxable income and whether the activity rises to a trade or business, with a safe harbor for landlords who keep separate books, log at least 250 hours of rental services per year, and maintain contemporaneous records. On $40,000 of net rental income, the deduction shields $8,000.
1031 Exchange
When you sell, capital gains can be deferred by reinvesting proceeds into another qualifying investment property under a 1031 like-kind exchange. You have 45 days to identify the replacement property and 180 days to close.8Office of the Law Revision Counsel. 26 U.S. Code 1031 – Exchange of Real Property Held for Productive Use or Investment The tax is deferred, not eliminated, but the deferral improves long-term ROI relative to investments where gains are taxed at every sale.
Where the Numbers Usually Go Wrong
The mistake that kills more deals isn’t in the formulas. It’s in the assumptions. Too optimistic on rent growth. Too light on vacancy. No capex reserve, or one so small it wouldn’t cover a water heater. Insurance quoted at the seller’s rate rather than a landlord policy for a new owner. Appreciation baked in at a rate the market hasn’t sustained.
Run the analysis with realistic vacancy, an actual insurance quote, honest maintenance and capex reserves, and 0% to 2% appreciation. Check cash-on-cash for this year’s return, cap rate for whether the price is fair, DSCR for whether the property survives a bad month, and total ROI or IRR for the multi-year picture. A deal that looks good across all of those, under conservative inputs, is the kind worth pursuing. One that only works when a single number is generous is a deal the market will eventually correct for you.