How to analyze a rental property

Analyzing a rental is not one calculation. It is four or five questions, each answered by a different number, and it is easy to fall into asking one number to answer all of them.

Step 1: What does the property earn?

Everything else is built on net operating income. It is the rent the building collects after vacancy, less what it costs to run: taxes, insurance, management, maintenance, utilities the owner pays, and a reserve for the things that will need replacing.

It leaves out four things on purpose: the mortgage payment, income taxes, depreciation and capital improvements. Including any of them corrupts every ratio built on NOI, because each of those depends on who owns the building or how they financed it, not on what the building does.

Everything downstream inherits the quality of the NOI. Rent that is assumed rather than leased, expenses that are estimated rather than documented, and a vacancy allowance of zero all flatter every number that follows. The cap rate calculator builds the operating statement line by line for exactly this reason.

Step 2: How is it priced?

Cap rate is NOI divided by the price of the property. It measures the building and deliberately ignores how you pay for it, which is what makes it the right number for comparing one property against another. The formula, and the ways it produces a believable wrong number, are worked through in the cap rate formula guide.

Whether a given cap rate is attractive depends on the market, the asset class and the rate environment, so there is no figure on this site to hold yours against. What you can do is compare it to what similar buildings in the same submarket are trading at, and to what the same money would earn elsewhere. Both of those are covered in what is a good cap rate.

The other thing to understand at this step is what cap rate cannot see. It contains no loan, so it cannot tell you whether you can afford the property at today's interest rate. That is the difference between cap rate and cash-on-cash return, and it is the reason there are more steps.

Step 3: Can the income carry the loan?

The debt service coverage ratio compares the income to the payment. Above 1.00 the income covers the payment; below it, the shortfall comes out of your pocket.

It is the step where two formulas travel under one name. Commercial underwriting divides NOI by debt service. Rental loan programs commonly divide gross rent by principal, interest, taxes, insurance and dues. They give different answers on the same property, and which one applies is set by your lender, not by you. What is DSCR works through one building scored both ways, and the DSCR loan calculator lets you measure against the minimum your lender actually quoted.

Step 4: What does my own money earn?

Cash-on-cash return divides a year's pre-tax cash flow by the cash you put in. It is the first step where you appear in the calculation: your down payment, your closing costs, your loan.

Because the loan is inside it, it moves with your financing in a way cap rate never does. The same building can return very differently at two different interest rates, which is why this is the number to run when you are choosing between ways of buying one property. What does cash-on-cash return mean covers what belongs in each half of the formula and the part of your return it leaves out. The cash-on-cash calculator collects the cash invested as separate components so the denominator is the real one.

One property, every step

Here is a single building run through all of them. It is the same property used throughout these guides, so the numbers will be familiar if you have read any of them.

Read it top to bottom and the answers disagree. The price and the income are the same in every row, and yet the building looks different depending on the question. On NOI it does not quite cover its debt; on the rental-loan method it clears comfortably; and on your own cash it loses money in the first year.

None of those readings is wrong. They are each correct about the thing they measure. The analysis is not choosing the flattering one; it is knowing which one the decision in front of you depends on.

Which number for which decision

Step 5: When you sell

Everything above is about buying and holding. Selling adds a different question: how much of the gain is taxable now, and how much can be deferred by exchanging into another property. The 1031 exchange calculator estimates the realized gain, the boot, the deferral and the two deadlines that cannot be extended.

It is an estimate, not advice. Whether an exchange qualifies depends on facts about the property and how it was held that no calculator can see, so use it to see the shape of the outcome before you speak to a qualified intermediary and a tax professional.

What this analysis does not contain

Every number above is a snapshot of one period. None of it forecasts appreciation, rent growth or the cost of a major repair, and none of it models taxes on the income while you own it. Those matter, and they need assumptions that cannot be sourced, so this site leaves them to you rather than supply guesses that look like arithmetic.

What the numbers do is tell you, quickly and honestly, whether a deal is worth the harder work of underwriting the things they cannot see.