How do you calculate whether a rental property makes money?
Start with rent, subtract vacancy and running costs to get net operating income (NOI), then subtract the mortgage and a reserve for big replacements. What's left is cash flow. In this example, $17,642 of NOI minus $17,963 of loan payments and a $1,380 reserve leaves -$1,701 for the year.
Cap rate = NOI ÷ price. Cash-on-cash = cash flow ÷ cash you put in. DSCR = NOI ÷ loan payments.| Line | Year | Month |
|---|---|---|
| Rent | $27,600 | $2,300 |
| Vacancy, 5% | -$1,380 | -$115 |
| Management, 8% of rent collected | -$2,098 | -$175 |
| Repairs, 5% | -$1,380 | -$115 |
| Property tax, 1.2% of price | -$3,600 | -$300 |
| Insurance | -$1,500 | -$125 |
| NOI | $17,642 | $1,470 |
| Capex reserve, 5% | -$1,380 | -$115 |
| Loan payments | -$17,963 | -$1,497 |
| Cash flow | -$1,701 | -$142 |
Here, the cap rate is 5.88%, cash-on-cash is -2.02% on $84,000 of cash, and DSCR is 0.98. This tool leaves the capex reserve out of NOI, so its cap rate is before reserves. Some investors count it the other way, so compare like with like.
Why can a rental have a positive cap rate and negative cash flow?
Cap rate ignores your loan. This property earns 5.88% on its price before financing, but the loan's payments cost 7.98% of the loan amount each year. When the loan's yearly cost is above the cap rate, borrowing lowers your return on cash instead of raising it. The cap rate is the same in every row below, while the cash changes completely.
| Rate | Down | Loan payments a year | Cash flow a year | DSCR |
|---|---|---|---|---|
| 5% | 25% | $14,494 | $1,768 | 1.22 |
| 5% | 40% | $11,595 | $4,667 | 1.52 |
| 6% | 25% | $16,188 | $75 | 1.09 |
| 6% | 40% | $12,950 | $3,312 | 1.36 |
| 7% | 25% | $17,963 | -$1,701 | 0.98 |
| 7% | 40% | $14,370 | $1,892 | 1.23 |
| 8% | 25% | $19,812 | -$3,549 | 0.89 |
| 8% | 40% | $15,849 | $413 | 1.11 |
To break even here, you'd need $2,483 of rent, or a price near $276,338 at the same rate and down payment share. To check the loan payment alone, use the mortgage calculator. Lenders on rentals may set their own DSCR minimums and rates, so ask them directly.
What is the total return on a rental property over time?
Total return adds cash flow, appreciation, and loan paydown, then subtracts selling costs and what you paid upfront. Over 10 years in this example, that's $6,799 of cash flow, $103,175 of appreciation, and $31,922 of paydown, less $24,190 to sell and $9,000 to buy. The total is $108,705, about 8.5% a year on your cash.
| Hold | 0% a year | 2% a year | 3% a year | 5% a year |
|---|---|---|---|---|
| 5 years | -$17,273 | $12,078 | $27,643 | $60,639 |
| 10 years | $11,721 | $73,477 | $108,705 | $189,069 |
| 15 years | $64,473 | $162,008 | $221,820 | $368,731 |
| 20 years | $146,788 | $283,825 | $374,112 | $613,018 |
Appreciation carries most of this. Set it to zero and the 10-year profit drops to $11,721. Short holds can also lose money, because selling costs arrive all at once. To compare this with another investment, see the ROI calculator.
| Down payment | Cash in | Year 1 cash flow | Cash-on-cash | 10-year profit |
|---|---|---|---|---|
| 20% | $69,000 | -$2,898 | -4.2% | $98,858 |
| 25% | $84,000 | -$1,701 | -2.02% | $108,705 |
| 40% | $129,000 | $1,892 | 1.47% | $138,247 |
| 100% | $309,000 | $16,262 | 5.26% | $256,415 |
How do depreciation and taxes affect a rental property?
This is a simplified view. IRS Publication 527 says residential rental buildings are depreciated over 27.5 years using the straight-line method, and land can't be depreciated. On our $300,000 home with 20% as land (an example), a full year's depreciation is $8,727. You don't spend that cash, but it can reduce taxable rental income.
That can create a tax loss even when the property is short on cash. Here, NOI less $15,678 of interest and depreciation gives -$6,762. Losses are limited, though. IRS Publication 925 allows up to $25,000 of rental losses against other income if you actively participate, and that allowance shrinks by 50 cents per dollar of modified adjusted gross income above $100,000. Married people filing separately have lower limits.
| Modified adjusted gross income | Special allowance | Loss used this year | Tax saved | Loss carried forward |
|---|---|---|---|---|
| $90,000 | $25,000 | $6,762 | $1,623 | $0 |
| $110,000 | $20,000 | $6,762 | $1,623 | $0 |
| $125,000 | $12,500 | $6,762 | $1,623 | $0 |
| $140,000 | $5,000 | $5,000 | $1,200 | $1,762 |
| $150,000 | $0 | $0 | $0 | $6,762 |
Depreciation isn't free money. Publication 527 says it reduces your basis for figuring gain or loss on a sale, so it can raise your tax when you sell. The calculator's optional tax sketch covers one year only and leaves out sale taxes, state tax, and more. A tax professional can run your real numbers.
When rental property numbers can mislead you
- Rent from a listing isn't your rent. Check similar homes nearby, and remember one empty month a year is about 8.3% vacancy, more than the 5% in our example.
- Big repairs are lumpy. A reserve smooths costs on paper, while a roof bill arrives on one day. Keep cash on hand beyond your down payment.
- Your time has a cost. Setting management to zero raises the return only because you're doing the job yourself.
- Costs grow, and tax bills can reset. A sale can trigger a new property tax assessment. Check with your county before you rely on the seller's bill.
- Local rules vary. Licenses, rent limits, and short-term rental rules depend on where the home is. Check with your city, and consider an accountant or attorney for a real purchase.
Common questions
What is a good cap rate?
There isn't one right number. It depends on the area, the property, and interest rates, and we don't publish averages. A more useful test is whether the cap rate beats your yearly loan cost, shown here as 7.98% on this example. Below that, borrowing lowers your cash yield.
What does DSCR mean, and what is a good one?
DSCR is NOI divided by loan payments. At 1.00, NOI just covers the payments. Below that, NOI falls short. Lenders set their own minimums, so ask each one. This example is 0.98.
What is the 1% rule for rentals?
It's a rule of thumb that says monthly rent should be at least 1% of the price. Here, $2,300 on $300,000 is 0.77%. It's only a quick filter, since it ignores your rate, taxes, and costs. Running the full numbers is safer.
Should I count appreciation?
Count it separately. A deal that only works with appreciation is a bet on future prices. Try 0% in the calculator to see what the property earns without it.
Can I download the numbers?
Yes. The yearly cash flow table and the loan schedule both download as CSV files that you can open in a spreadsheet.
Sources
- Publication 527: Residential Rental Property · Internal Revenue Service
- Publication 925: Passive Activity and At-Risk Rules · Internal Revenue Service