The short answer
- Net operating income (NOI) is rent after vacancy less operating costs, before the mortgage.
- Cap rate is NOI ÷ price; cash-on-cash return is cash flow ÷ the cash you put in; DSCR is NOI ÷ mortgage payments.
- A $300,000 home renting for $2,500 a month, bought with 25% down at 7.5%, makes just $171 a year in cash flow, but about 10.3% a year over 10 years once loan paydown and 3% growth are counted.
- Depreciation over 27.5 years shelters much of the income from tax, but is partly taxed back when you sell.
A worked example
A $300,000 single-family home, 25% down, $9,000 of closing costs, a $225,000 loan at 7.5% for 30 years, rent of $2,500a month and the calculator’s default expenses:
- Gross rent$2,500 × 12$30,000
- Vacancy5%−$1,500
- Operating expensesManagement, repairs, reserves, tax, insurance−$9,450
- Net operating income$19,050
- Mortgage payments$1,573.23 a month−$18,879
That is about $14 a month on $84,000 of cash. The property is not a bad investment, as later sections show, but it is not an income stream either.
Income and vacancy
Gross rent is the rent if the home is let every day of the year. Real income is lower: tenants move out, units need cleaning and repairs between tenants, and some rent goes unpaid. A 5% vacancy allowance is about 18 days a year; areas with high turnover need more.
Check rent against listings for the same size of home nearby, and be wary of a seller’s rent roll that is above the market. Parking, laundry, storage or pet fees can add income; enter them under More options.
Operating expenses
Operating expenses are everything it costs to run the property, except the mortgage. In year one of the example:
The capital reserve is money set aside for big replacements: roof, water heater, HVAC, flooring and appliances. It does not leave your account every month, but if you do not set it aside, one replacement can wipe out years of cash flow. Some states and counties tax rental homes at higher rates than owner-occupied ones; check with the county assessor.
Net operating income
NOI is income after vacancy less operating expenses: $28,500 − $9,450 = $19,050 in the example. It leaves out the mortgage on purpose, so you can compare properties no matter how they are financed. It also leaves out depreciation and income tax.
Cap rate
The capitalization rate is NOI ÷ price: $19,050 ÷ $300,000 = 6.35%. It is the return you would earn in year one if you paid cash, before income tax. Investors use it to compare properties and markets; buyers of apartment buildings often value them by dividing NOI by the local cap rate.
Compare it with your mortgage rate
When the cap rate is below your mortgage rate, every borrowed dollar costs more than it earns, so borrowing lowers your cash return. In the example the cap rate (6.35%) is below the 7.5% rate, which is why the cash flow is thin.
Cash flow
Cash flow is NOI less the mortgage payments, principal and interest. It is the money you actually keep each year. It usually grows over time because rent rises while a fixed-rate payment does not: in the example from $171 in year one to $5,977 in year 10, with rent and expenses both rising 3% a year.
Break-even occupancy shows how much vacancy the deal can take: the property must be let 94.4% of the year to cover all its costs and the loan. That leaves little room for a long vacancy.
Cash-on-cash return
Cash-on-cash return is year-one cash flow ÷ the cash you put in. Cash in the example is the $75,000 down payment plus $9,000 closing costs, $84,000 in all, so the return is $171 ÷ $84,000 = 0.20%. Managing the property yourself (no 8% fee) would lift cash flow to $2,451, or 2.92%, but you would be paid in your own time.
Debt service coverage
The debt service coverage ratio is NOI ÷ the year’s mortgage payments: $19,050 ÷ $18,879= 1.01. At 1.00 the rent exactly covers the loan; below it you make up the difference. Lenders that underwrite loans on a property’s rental income (often called DSCR loans) commonly look for about 1.2 or more.
The 1% and 50% rules
Two rules of thumb help screen listings before you run full numbers. The 1% rule looks for monthly rent of at least 1% of the price. The example rents for 0.83%, and it shows: cash flow is close to zero. The 50% rule says operating expenses (not the mortgage) eat about half the rent over time. The example’s 33% is leaner, because it has no HOA or utilities and a new-ish home.
Neither rule replaces real figures. Use them to decide which properties are worth a closer look.
How much to put down
| Down payment | Cash flow a year | Cash-on-cash | DSCR | 10-year IRR |
|---|---|---|---|---|
| 20% | −$1,087 | −1.58% | 0.95 | 10.66% |
| 25% | $171 | 0.20% | 1.01 | 10.27% |
| 30% | $1,430 | 1.44% | 1.08 | 9.96% |
| 40% | $3,947 | 3.06% | 1.26 | 9.52% |
| 50% | $6,464 | 4.07% | 1.51 | 9.21% |
| All cash | $19,050 | 6.17% | No loan | 8.46% |
More debt means thinner cash flow but a slightly higher long-run return, because a small amount of cash controls the whole property’s growth. That only holds if the property grows; leverage magnifies losses too. Investment property loans usually need 15% to 25% down and cost more than a loan on your own home.
Interest rates
| Rate | Cash flow a year | Cash-on-cash | DSCR |
|---|---|---|---|
| 6.0% | $2,862 | 3.41% | 1.18 |
| 6.5% | $1,984 | 2.36% | 1.12 |
| 7.0% | $1,087 | 1.29% | 1.06 |
| 7.5% | $171 | 0.20% | 1.01 |
| 8.0% | −$762 | −0.91% | 0.96 |
Each half point moves cash flow by about $900 a year on this loan. Our mortgage calculator shows the payment at any rate.
Depreciation
The IRS lets you deduct the cost of a residential rental building, but not the land, over 27.5 years in equal amounts (Publication 527). The first year uses the mid-month rule: a home placed in service in January gets 11.5 months.
- Price plus closing costs$309,000
- Less land20%−$61,800
- Building basis$247,200
- First year11.5 months$8,615
Your county’s assessment often splits land and building values, which supports the split you use. Some closing costs belong in the basis and others are deducted differently; Publication 527 lists them.
Taxes on rental income
Taxable rental profit is roughly NOI less mortgage interest and depreciation. In the example, year one is a loss of $6,369 on paper even though cash flow is positive, and the property shows a taxable profit only from year 9.
Rental losses are passive. If you actively take part in managing the property, you can deduct up to $25,000 a year of losses against other income; the allowance phases out between $100,000 and $150,000of modified AGI (Publication 925). Losses you can’t use carry forward to later years or the year you sell. The calculator’s figures are before income tax.
The return over 10 years
Hold the example for 10 years with rent, costs and value each rising 3% a year, then sell for 6% in costs:
| Item | Amount |
|---|---|
| Cash invested | $84,000 |
| Cash flow over 10 years | $29,599 |
| Sale price | $403,175 |
| Selling costs | −$24,190 |
| Loan payoff | −$195,289 |
| Cash from the sale | $183,696 |
| Profit before tax | $129,295 |
You get back $213,295 for $84,000, an equity multiple of 2.54×, or an internal rate of return of about 10.3% a year. Most of it comes from loan paydown and growth, not cash flow. With no growth in value, the profit falls to $32,310 and the return to about 3.6% a year. Our compound interest calculator shows what the same $84,000 could grow to elsewhere.
Selling: recapture and capital gains
When you sell, depreciation comes back to bite. The depreciation you took (or were allowed to take) is taxed at up to 25% as unrecaptured section 1250 gain. Over 10 years the example takes $89,516 of depreciation, so up to about $22,379 of tax. Any further gain is taxed at long-term capital gains rates of 0%, 15% or 20%, and the 3.8% net investment income tax can apply at higher incomes. Rental homes do not get the home sale exclusion. Our capital gains tax calculator estimates the tax on the gain.
A 1031 exchange into another investment property can defer the tax; it has strict deadlines and needs a qualified intermediary.
Risks to plan for
- Vacancy
- Months without rent
- Big repairs
- Roof, HVAC, foundation
- Rising costs
- Insurance and tax reassessment
- Tenants
- Late payment, eviction costs
- Rules
- Rent control, licensing, inspections
- Liquidity
- Months to sell, 6%+ to exit
Keep a cash reserve of several months of expenses and mortgage payments for each property, on top of the capital reserve.
Common mistakes
- Counting rent for 12 months with no vacancy.
- Leaving out repairs, a capital reserve or management because you plan to do it yourself.
- Using the seller’s property tax bill, which may rise after the sale.
- Buying a property with negative cash flow and relying only on price growth.
- Forgetting depreciation recapture when working out what you will keep from a sale.
Using the calculator well
- Enter the price, down payment, a real investment-property rate quote and the market rent.
- Pick the state for typical property tax, then check the county’s figure and your insurance quote under More options.
- Set vacancy, management, repairs and reserves to fit the property’s age and area.
- Set how long you plan to hold it, growth assumptions and selling costs.
- Try a stress test: 10% vacancy, no value growth, a rate 1 point higher. If the deal still works, it is robust.
Key numbers
| Item | Figure |
|---|---|
| Residential rental depreciation | 27.5 years, straight line, mid-month |
| Tax on depreciation at sale | up to 25% |
| Passive loss allowance (active participation) | up to $25,000, phased out from $100,000 to $150,000 MAGI |
| Long-term capital gains rates | 0%, 15%, 20% |
| Net investment income tax | 3.8% above $200,000 single, $250,000 married |
| Typical property tax (Census Bureau, 2024) | about 0.89% of value a year |
| 1% rule | monthly rent at least 1% of the price |