Rental Property Investing: Run the Numbers First

The three numbers that matter

Net operating income is annual rent minus all operating expenses, before financing. Cap rate is that figure divided by the purchase price, and it lets you compare properties independently of how they are financed.

Cash-on-cash return is annual pre-tax cash flow divided by the cash you actually put in — deposit, closing costs and initial repairs. It is the number that tells you what your money is earning, and it is the one to compare against alternatives.

Screening rules and the 50% test

The 1% rule — monthly rent of at least 1% of the purchase price — is a screening heuristic, not an analysis, and it fails in high-price markets. Use it to shorten a list, never to decide.

The 50% rule is more useful: assume operating expenses consume about half of gross rent before the mortgage. If the deal only works when expenses are assumed at 20%, it does not work.

Costs beginners leave out

The gap between projected and actual returns is almost always a missing expense line.

• Vacancy, budgeted at 5-10% of gross rent even in strong markets.
• Capital expenditure reserves for roof, HVAC, water heater and flooring — these are not maintenance.
• Property management at roughly 8-10% of rent, whether you pay it or absorb the work yourself.
• Landlord insurance, which costs more than a homeowner policy, plus higher property tax after reassessment.
• Turnover costs: cleaning, repainting, letting fees and the lost rent between tenants.

Financing and tax treatment

Investment property mortgages require larger deposits, typically 15-25%, carry higher rates than owner-occupied loans, and often require cash reserves. House hacking — living in one unit of a small multi-family building — accesses owner-occupied terms and is the cheapest entry point available.

Tax treatment is a genuine advantage: mortgage interest, operating costs, insurance and depreciation are deductible against rental income, and depreciation often shelters a large part of the cash flow. It is recaptured on sale, so treat it as deferral rather than exemption, and take advice on 1031 exchanges before selling.