How Do I Calculate the Return on a Rental Property?

Cap Rate

Calculated by dividing the property's annual net operating income (NOI) by its purchase price. NOI is rental income minus operating expenses (property taxes, insurance, maintenance, management fees, vacancy allowance) but before mortgage payments. Cap rate shows the property's return independent of financing.

Cash-on-Cash Return

Calculated by dividing the annual pre-tax cash flow (rental income minus all expenses including mortgage payments) by the total cash invested (down payment, closing costs, initial repairs). Cash-on-cash return shows your actual return on the money you invested.

What to Include in Operating Expenses

Property taxes, homeowners insurance, maintenance reserves (commonly estimated at a percentage of the property value), property management fees (if applicable), HOA fees, vacancy allowance, and any special assessments.

A Hypothetical Example

A property purchased for $650,000 with a 20% down payment of $130,000 plus $30,000 in closing costs and initial repairs, for a total cash invested of $160,000. Annual rental income of $48,000, minus operating expenses of $18,000, leaves $30,000 in NOI. The cap rate is approximately 4.6%. If the annual mortgage payment is $24,000, the cash flow is $6,000 and the cash-on-cash return is approximately 3.75% on the $160,000 total cash invested.

This is a simplified illustration and actual returns vary significantly based on location, property condition, and market conditions.

Important Note

These are general educational calculations. Actual returns depend on many property-specific factors. Eduardo can help you analyze specific properties and markets.