What is a good cap rate for a rental property?

Depends on market and risk tolerance. 4–6% is typical for stable urban markets. 7–10%+ is common in smaller markets with higher risk. Very low cap rates (2–3%) are common in prime locations where appreciation is the main return driver.

What is the 1% rule in real estate investing?

The 1% rule states that monthly rent should be at least 1% of the purchase price. A $300,000 property should rent for $3,000/month. It is a quick screening tool — properties meeting this threshold are more likely to cash flow positively.

Should I include mortgage in cap rate calculation?

No. Cap rate is deliberately financing-neutral — it uses NOI before debt service. This lets you compare properties regardless of how they are financed. Cash-on-cash return factors in financing.

How do I account for property appreciation in ROI?

Calculate total return: (Annual Cash Flow + Annual Appreciation + Principal Paydown) / Total Cash Invested. At 3% annual appreciation on a $300,000 property, that is $9,000/year in equity growth before selling.

Formula Guide

How to Calculate Rental Property ROI

Rental property return on investment (ROI) is measured in several ways depending on how you financed the purchase. Cash-on-cash return compares annual cash flow to the cash you invested (down payment + closing costs). Cap rate compares net operating income to total property value regardless of financing. Understanding both lets you evaluate and compare investment properties on equal footing.

Last updated: March 31, 2026

The Formula

Net Operating Income (NOI) = Gross Rental Income − Operating Expenses
Operating Expenses = Property Tax + Insurance + Maintenance + Management + Vacancy

Cap Rate = NOI / Property Value × 100
Cash-on-Cash Return = Annual Pre-Tax Cash Flow / Total Cash Invested × 100
Annual Cash Flow = NOI − Annual Mortgage Payments

Vacancy: typically budget 5–10% of gross rent. Maintenance: budget 1% of property value per year. Management: 8–12% of gross rent if using a property manager.

Variable Definitions

Symbol	Name	Description
NOI	Net Operating Income	Annual rental income minus all operating expenses (but before mortgage payments)
Cap Rate	Capitalisation Rate	NOI as a percentage of property value — independent of financing. A higher cap rate = higher return and typically higher risk.
CoC	Cash-on-Cash Return	Annual cash flow (after mortgage) as a percentage of cash invested — most relevant for leveraged purchases

Step-by-Step Example

A property costs $300,000. Down payment: $60,000 (20%). Monthly rent: $2,000. Annual expenses: taxes $3,600, insurance $1,200, maintenance $3,000, vacancy 8%.

Given

Property price:$300,000Down payment:$60,000Annual gross rent:$24,000 (2,000 × 12)Vacancy (8%):$1,920Operating expenses:$3,600 + $1,200 + $3,000 = $7,800

Solution

1
Effective gross income: $24,000 − $1,920 = $22,080
2
NOI: $22,080 − $7,800 = $14,280
3
Cap rate: $14,280 / $300,000 × 100 = 4.76%
4
Annual mortgage (6.8%, 30yr, $240k): ≈ $15,696/year
5
Annual cash flow: $14,280 − $15,696 = −$1,416 (negative)
6
Cash-on-cash return: −$1,416 / $60,000 = −2.4%

Cap rate 4.76% is acceptable. But cash-on-cash is negative at current rates — the property cash flows negatively unless rent rises or mortgage rate decreases.

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Common Mistakes to Avoid

Excluding vacancy from income — assume 5–10% vacancy even for a currently occupied property.

Using gross rent instead of NOI for cap rate — cap rate always uses NOI (after expenses, before mortgage).

Forgetting closing costs in cash invested — buying costs 2–4% of the purchase price; add this to your cash invested for accurate CoC.

Relying only on appreciation — cash flow should at least cover itself; banking on appreciation alone is speculative.

Frequently Asked Questions

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