Every rental property deal starts with a spreadsheet. The investors who lose money are usually the ones who skipped it — or only modeled the best case. This guide walks through the three core metrics every landlord should calculate before making an offer: cap rate, cash-on-cash return, and the 1% rule.
The 1% Rule: A Quick Filter
The 1% rule is a rough screening tool: monthly rent should be at least 1% of the purchase price. A $250,000 property needs to generate $2,500/month in rent to pass the screen. It's not a buying criterion — it's a filter to eliminate deals without running full numbers.
In many markets, especially high cost-of-living cities, the 1% rule is nearly impossible to hit. In those markets, investors rely more heavily on appreciation. In cash flow markets (Midwest, Southeast), 1% or better is achievable and expected.
Monthly Rent ÷ Purchase Price × 100 ≥ 1% Example: $1,800/mo rent on a $175,000 property → 1,800 ÷ 175,000 × 100 = 1.03% ✓ Passes Example: $2,200/mo rent on a $400,000 property → 2,200 ÷ 400,000 × 100 = 0.55% ✗ Fails
Cap Rate: The Property's Unlevered Return
Cap rate (capitalization rate) measures a property's return independent of financing — as if you paid all cash. It's the ratio of Net Operating Income (NOI) to purchase price.
NOI = Gross Rent − Vacancy − Operating Expenses Cap Rate = NOI ÷ Purchase Price × 100 Example: • Gross rent: $24,000/yr • Vacancy (5%): −$1,200 • Taxes, insurance, maintenance, mgmt: −$8,000 • NOI: $14,800 • Price: $200,000 → Cap Rate = 14,800 ÷ 200,000 = 7.4% Target: 6–9% for most residential markets
Cash-on-Cash Return: Your Actual Return on Invested Cash
When you use a mortgage to buy a rental, the return that matters most is cash-on-cash (CoC) — how much annual cash flow you're generating on the dollars you actually invested (down payment + closing costs).
Annual Cash Flow = NOI − Annual Debt Service CoC = Annual Cash Flow ÷ Total Cash Invested × 100 Example: • NOI: $14,800 • Annual mortgage payments: $11,400 • Annual cash flow: $3,400 • Down payment + closing costs: $52,000 → CoC = 3,400 ÷ 52,000 = 6.5% Target: 6–10%+ for most investors
Building the Full P&L
The cap rate and CoC calculations are only as good as your expense estimates. Most first-time investors underestimate expenses. Use these benchmarks:
- Vacancy: budget 5–8% of gross rent even in strong markets — tenants turn over
- Property management: 8–12% of collected rent if using a manager; budget it even if self-managing (your time has value)
- Maintenance and repairs: 1–2% of property value per year ($2,000–$4,000 on a $200k property)
- CapEx reserve: set aside 5–10% of rent for big-ticket replacements (roof, HVAC, water heater)
- Property taxes and insurance: get actual quotes, not estimates
- Utilities: if landlord-paid, get 12 months of actual bills from the seller
What Makes a Deal Work
A good rental property passes these tests: cap rate above 6%, positive cash flow (not break-even), CoC return above your alternative investments, and a debt-service coverage ratio (NOI ÷ annual mortgage payment) above 1.25. A DSCR below 1.0 means the property's income doesn't cover its own debt — that's negative cash flow, meaning you fund it out of pocket every month.
Run scenarios: what if rent drops 10%? What if vacancy runs 3 months? What if the roof fails in year 2? Good deals survive all three.
Most bad rental property investments look fine on paper because the investor used optimistic rent and ignored expenses. Build your P&L with conservative inputs — realistic vacancy, full management cost, real maintenance reserves — and only buy when the numbers work at those levels. The Rental Property ROI Calculator will model all three metrics for any property you're evaluating.
