Apollo AdvisingHow to analyze a rental property before you buy
How to analyze a rental property before you buy: cap rate, cash-on-cash return, DSCR, and the expense lines first-time buyers leave out, with a worked example.
Short answer. Start with net operating income: a year of realistic rent, minus vacancy and every operating cost, before the mortgage. Divide it by the price for the cap rate, subtract the loan payments for cash flow, and divide cash flow by the cash you put in for cash-on-cash return. Most bad purchases come from leaving costs out, not from the math.
Step 1: realistic income
Use rent for comparable homes that actually leased recently, not the seller's pro forma or the highest listing you can find. Then take out vacancy. Even a well-run long-term rental sits empty between tenants; 5% to 8% of gross rent is a common planning range.
Step 2: every operating cost
This is where first-time buyers go wrong. Include:
- Property tax, based on what the purchase price will likely do to the assessed value, not the seller's current bill
- Insurance, quoted for a landlord policy at this address
- Maintenance and a reserve for capital items such as roofs, HVAC, and water heaters. See how to budget for them
- Property management, even if you plan to self-manage, because your time has a cost. See the management guide
- HOA dues, lawn, pest, pool, and any utilities the owner pays
- Leasing and turnover costs: cleaning, paint, and listing fees
Step 3: the three numbers
| Metric | How to calculate | What it tells you |
|---|---|---|
| Cap rate | Net operating income ÷ price | What the property earns on its price, before financing. Useful for comparing properties. |
| Cash-on-cash return | Annual cash flow after the mortgage ÷ cash invested | What your down payment and closing costs earn in cash each year. |
| DSCR | Net operating income ÷ annual mortgage payments | How comfortably the income covers the debt. Lenders look at this. |
A worked example
A $320,000 house renting for $2,400 a month, bought with 25% down and a 30-year loan at 7.0%. Illustrative numbers, not a forecast for any market.
| Line | Annual |
|---|---|
| Gross rent | $28,800 |
| Less vacancy at 5% | −$1,440 |
| Property tax | −$7,200 |
| Insurance | −$2,600 |
| Maintenance 10%, capital reserve 5%, management 8% of rent | −$6,624 |
| Net operating income | $10,936 |
| Mortgage payments | −$19,161 |
| Cash flow | −$8,225 |
That is a cap rate of 3.4%, a DSCR of 0.57, and cash-on-cash of -9.2% on about $89,000 invested. In other words, this house costs money to hold every year at today's rates, even though the rent looks strong at first glance. That does not automatically make it a bad purchase, since loan paydown and appreciation also count, but you should know the number going in and decide whether you can carry it.
Shortcuts to treat with caution
- The 1% rule (monthly rent at least 1% of price) is a quick screen, not an analysis. It ignores taxes, insurance, and condition, which vary enormously.
- Seller pro formas often leave out management, reserves, and vacancy.
- Short-term rental projections from data tools can be wildly optimistic for a specific house. Treat them as a ceiling.
Where we fit
Bring a property you are considering and we will build the full picture together: realistic rent, every cost, financing, and the questions for your inspector, lender, and insurance agent. You can also order a written property analysis for $99. More on buying a rental property.
Want this run on your property?
$199 per hour, billed in 15-minute increments, or $499 for a three-hour block. The first 30 minutes are free.
Free worksheet: hold, sell, or 1031?
The 12 questions Denver works through with every owner deciding whether to keep, sell, or exchange a rental, in a two-page PDF. Plain language, no sales pitch.
Go deeper
Short-term vs medium-term vs long-term calculatorCompare what the same property keeps under each rental strategy, with your own numbers.How much to budget for maintenance and capital expensesPercent-of-rent rules, component lifespans, and a reserve schedule you can build in an afternoon.DSCR loans for rental property, explainedHow lenders calculate the ratio, what the loans usually cost, and when one fits.Airbnb, medium-term, or long-term: comparing what you keepA side-by-side of costs, time, and rules, with a worked example on the same house.This page is general education, not legal, tax, investment, insurance, or lending advice. See our disclosures.