The Three Numbers That Matter
- Cash flow — rent minus every expense including the mortgage. Negative cash flow means the property costs you money each month regardless of what it may be worth later.
- Cap rate — net operating income divided by price. It measures the property itself, ignoring how it is financed, which makes it the right tool for comparing two buildings.
- Cash-on-cash return — annual cash flow divided by cash invested. This is what your money actually earns.
The Expenses Beginners Miss
The classic error is subtracting only the mortgage from the rent and calling the rest profit. A realistic operating budget runs 35–50% of gross rent before any mortgage payment:
| Expense | Typical level |
|---|---|
| Vacancy | 5–8% of gross rent |
| Maintenance | 5–10% of gross rent |
| Capital expenditure reserve | 5–10% of gross rent |
| Property management | 8–10% of collected rent |
| Property tax | 0.3–2.5% of value a year |
| Insurance | $1,200–$3,000 a year |
The capital expenditure reserve is the one most often skipped. Roofs, water heaters and HVAC systems fail on a schedule measured in decades, and a landlord who has not been setting money aside meets them as a crisis.
Screening Rules
The 1% rule says monthly rent should be at least 1% of the purchase price — $2,600 on a $260,000 house. It is a fast filter, not an analysis, and in expensive coastal markets almost nothing passes it. The 50% rule says operating expenses excluding the mortgage will consume about half the rent; it is a useful sanity check against optimistic expense estimates.
Leverage Cuts Both Ways
Financing raises the return on your own cash when the property earns more than the loan costs, and destroys it when it does not. A property with a 6% cap rate financed at 7.25% loses money on every borrowed dollar — the loan is more expensive than the asset yields. In a high-rate environment, more equity is often the only way to make the numbers work.
Where the Return Actually Comes From
Rental property pays in four ways: cash flow, principal paydown by the tenant, appreciation, and tax treatment including depreciation. Cash flow is the only one that is certain. Strategies that rely on appreciation to justify negative cash flow are speculation with a landlord's workload attached.
Frequently Asked Questions
What is a good cap rate?
5–10% in most U.S. markets. Lower cap rates indicate expensive, stable areas; higher ones indicate cheaper markets with more risk or management burden.
Should I self-manage?
It saves 8–10% of rent and costs time, availability and the ability to say no. Model the property with management included — if it only works when you manage it yourself, it is a job rather than an investment.
How much cash do I need?
Investment property loans typically require 20–25% down, plus closing costs, initial repairs and a reserve of several months of expenses. On a $320,000 purchase that is realistically $95,000–$110,000.