Before you make an offer on a rental property, it helps to see how the rent you expect turns into the cash that is left each year. The arithmetic is not complicated. What takes care is the inputs: each figure should come from something you can point to, such as comparable listings, a tax bill, an insurance quote or a lender's estimate, rather than a hopeful guess.
This guide walks through the order of the calculation, a worked example with illustrative figures, and two ratios people often use to compare properties. It is general education, not financial, tax, legal, lending or investment advice.
Collect the inputs first
Write down each figure and where it came from before you calculate anything:
- Purchase price, plus closing costs and any repairs needed before the first tenant moves in.
- Expected monthly rent, based on comparable rentals you can document.
- A vacancy allowance: the share of the year you assume the unit could sit empty. This is your assumption, so record why you chose it.
- Operating costs you would pay: property tax, insurance, repairs and maintenance, property management, and any association fees or utilities the owner covers.
- Loan terms from a lender's quote, if you are financing: the annual total of the loan payments.
- The cash you would put in: down payment, closing costs and initial repairs.
Work from rent to cash flow
Take the figures in this order:
- Gross scheduled rent: monthly rent multiplied by 12.
- Effective income: gross rent minus your vacancy allowance.
- Net operating income: effective income minus operating costs. Loan payments are not an operating cost, so they are not subtracted here.
- Cash flow before tax: net operating income minus the annual loan payments.
Keeping loan payments separate lets you see how the property performs on its own and how much the financing changes the result.
A worked example with illustrative figures
The numbers below are invented to show the arithmetic. They are not market data or a forecast for any area.
Gross scheduled rent: $2,000 a month × 12 = $24,000.
Vacancy allowance of 5%: $1,200, so effective income is $22,800.
Operating costs: tax $3,000, insurance $1,800, repairs and maintenance $1,500, management $1,800 and other costs $600, a total of $8,700.
Net operating income: $22,800 − $8,700 = $14,100.
Annual loan payments from the lender's quote: $10,800.
Cash flow before tax: $14,100 − $10,800 = $3,300 a year, or $275 a month.
Two ratios people use to compare properties
Capitalization rate is net operating income divided by the purchase price. At an illustrative price of $240,000, $14,100 ÷ $240,000 is about 5.9%. It describes the property before financing, which makes it useful for comparing properties with each other.
Cash-on-cash return is the annual cash flow before tax divided by the cash you put in. If the down payment, closing costs and initial repairs total $60,000, $3,300 ÷ $60,000 is 5.5%. It reflects your financing, so it changes when the loan terms change.
Neither ratio includes taxes, appreciation, large future repairs or the time a purchase takes to manage. Treat them as ways to compare your own estimates, not as measures of whether a property is a good purchase.
Test the assumptions that move the result
Change one input at a time and recalculate. Lower the rent, raise the vacancy allowance, add a larger repair in the first year, use a higher insurance quote. Note which change moves cash flow the most; that is the figure worth checking hardest before you make an offer.
Keep the sources beside the numbers. When an agent, lender or adviser asks where a figure came from, you can show them.
If you want a workbook for this
The Real Estate Investor Calculator Bundle is described on its product page as “One Excel workbook containing five calculator sheets plus a README.” Its page lists Rental Analyzer, Fix and Flip, BRRRR, Rent vs Buy and Seller Net as separate worksheets, and states: “This is an educational planning tool, not financial, tax, legal, lending or investment advice. Results depend on your inputs and do not guarantee returns.”
Whatever tool you use, check the formulas and assumptions before relying on an output, and confirm figures with qualified professionals before you make an offer.