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Real Estate8 min read

Rental property maths most people get wrong

A rental that looks like it clears $400 a month often clears nothing. The gap is almost always the same four line items.

Paul GabrailFounder · Updated

Rent minus mortgage is not cash flow. It is the beginning of a calculation that most first-time landlords stop halfway through, which is why so many properties that looked like they cleared a few hundred dollars a month turn out to clear nothing.

The four expenses that get left out

  • Vacancy. A property is not rented every month of every year. Budget 5-8% of gross rent even in a strong market.
  • Maintenance. Things break on a schedule you do not control. 5-10% of rent is a reasonable reserve, higher on older stock.
  • Capital expenditure. A roof lasts 25 years and then costs $12,000. Spreading large replacements across the years between them is the only honest way to account for them.
  • Management. If you self-manage you are working for the property. Price the labour at the 8-10% a manager would charge, then decide whether the return justifies doing it yourself.

The metrics, and what each one is for

MetricWhat it measuresWhy it matters
Cap rateNet operating income ÷ purchase priceCompares properties independently of how they are financed
Cash-on-cashAnnual cash flow ÷ cash investedThe return on the money you actually put in
DSCRNet operating income ÷ debt serviceWhether the property covers its own loan. Lenders want 1.25 or better
1% ruleMonthly rent ÷ purchase priceA rough screen, not an analysis. Useful for discarding, not deciding

A worked example

A $320,000 duplex renting for $2,900 a month clears the 1% rule comfortably. With 25% down at 6.5% over 30 years, debt service runs about $1,517 a month. Taxes and insurance add roughly $500. So far it looks like $883 a month.

Now add the four omitted items: 6% vacancy ($174), 8% maintenance ($232), and 9% management ($261). Cash flow falls to about $216 a month — roughly $2,600 a year on $96,000 of equity plus closing costs, or under 2.5% cash-on-cash before appreciation and amortisation.

That may still be a reasonable deal once principal paydown and appreciation are counted. But it is a very different deal from the one the first calculation described, and knowing which one you are buying is the entire point.

Common questions

What is a good cash-on-cash return on a rental?

It depends on the market and your alternatives. Many investors target 8% or better on cash invested, since below that the return is competing directly with far more liquid options.

Does the 1% rule still work?

As a screen, yes — it quickly discards properties whose rent cannot support their price. It is not an analysis, and in higher-priced markets very few properties clear it, which does not automatically make them bad investments.

Paul Gabrail

Founder

Founder of Everything Money. Former commercial real estate investor who has spent two decades analysing businesses for his own account.

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