How to analyze a rental property
A rental is worth buying when the rent covers every cost of owning it and leaves enough left over for the risk you take on. This calculator works through that in the same order a lender or experienced investor would: income, then operating expenses, then the mortgage.
1. Income after vacancy
Start with monthly rent plus any other income, such as laundry or parking. No property is rented every day of the year, so subtract a vacancy allowance. The result is the income you can expect to actually collect.
2. Operating expenses and NOI
Operating expenses are the costs of running the property: property tax, insurance, HOA dues, owner-paid utilities, repairs, a reserve for big replacements like a roof or water heater (capital expenses), and property management. Income after vacancy minus operating expenses is net operating income (NOI). NOI leaves out the mortgage, so it describes the property, not your loan.
3. Cap rate
Cap rate is yearly NOI divided by the purchase price. It is the return you would earn paying all cash, which makes it useful for comparing properties with each other.
4. Cash flow, cash-on-cash return and DSCR
Subtract the monthly mortgage payment (principal and interest) from NOI to get cash flow.Cash-on-cash return is a year of cash flow divided by the cash you put in: the down payment plus closing costs and up-front repairs. DSCR (debt-service coverage ratio) is NOI divided by a year of mortgage payments. Above 1.0 means the property's income covers the loan; many lenders look for around 1.2 or more on investment loans.
Worked example
A $250,000 house with 20% down, a 7% 30-year loan and $7,500 in closing costs, renting for $2,400 a month. Taxes are $3,000 a year, insurance $1,500, with 5% vacancy, 5% repairs, 5% capital expenses and 8% management.
| Rent | $2,400.00 |
|---|---|
| Less 5% vacancy | −$120.00 |
| Property tax | −$250.00 |
| Insurance | −$125.00 |
| Repairs and maintenance | −$120.00 |
| Capital expenses | −$120.00 |
| Property management | −$182.40 |
| NOI | $1,482.60 |
| Mortgage on $200,000 | −$1,330.60 |
| Cash flow | $152.00 |
That is $17,791 of NOI a year, a cap rate of 7.12%, and $1,824 of yearly cash flow on $57,500 invested: a 3.17% cash-on-cash return with a DSCR of 1.11. Rent is 0.96% of the price, just under the 1% rule.