Four figures, four different questions
These get used interchangeably in conversation and they are not interchangeable. Each one deliberately leaves something out, and knowing what is left out is the whole skill.
| Figure | Formula | What it ignores |
|---|---|---|
| Gross yield | Annual rent ÷ price | Every expense, and vacancy |
| Net operating income | Effective income − operating expenses | The mortgage, tax, depreciation |
| Cap rate | NOI ÷ price | Financing, entirely and on purpose |
| Cash-on-cash | Cash flow after the loan ÷ cash invested | Appreciation and principal paydown |
Gross yield is annual rent divided by the price. It is the number in listing headlines because it is the largest one available. It says nothing about whether the property makes money.
Net operating income is what the property earns as a business, after vacancy and after every expense of running it, and before any question of how it was paid for. Property tax, insurance, maintenance, management and HOA are in. The mortgage payment is not. Neither is depreciation or your income tax.
Cap rate is NOI divided by the price. It excludes financing by definition, and that is the point: it describes the property rather than the buyer, so two people with completely different loans looking at the same building compute the same cap rate. It is how properties get compared to one another and how a market is described.
Cash-on-cash return is the annual cash flow after the mortgage, divided by the cash you actually put in. It includes financing by definition, because financing is what makes the two numbers differ. Borrow at a rate below the cap rate and cash-on-cash exceeds it, which is leverage working. Borrow above it and cash-on-cash falls below, which is leverage working in the other direction and does not feel different until the year the vacancy runs long.
Which price goes in the denominator
Cap rate is conventionally quoted on the purchase price, because that is what makes it comparable across deals and across markets. As a measure of what you personally earned it flatters you, since your capital included closing costs and rehab that produced no extra rent. This page shows both: the conventional figure on the price, and the same calculation on the all-in cost. Quote the first when comparing to the market, use the second when deciding whether your own money was well spent, and never move between them mid-argument.
The expense lines people leave out
An operating expense budget that comes to 20 percent of rent is usually a budget with holes in it. Across the industry, operating costs on a single-family rental commonly land somewhere between a third and a half of effective income once everything is counted, and the lines that go missing are always the same ones.
- Vacancy. Not an expense but a reduction in income, and it is not zero. Two to three weeks between tenants is 4 to 6 percent of a year, before any month a unit sits unlet.
- Capital reserve. A roof lasts decades and then costs five figures. Set aside for it monthly or be surprised by it once.
- Management. Eight to ten percent of collected rent if someone else does it. If you do it yourself the fee is zero and the work is not, and pricing your own labour at zero is how a marginal deal looks fine.
- Turnover costs. Paint, cleaning, listing, screening. These recur with every tenant change and belong in maintenance.
What none of this measures
Two genuine returns are missing from every figure on this page. Each mortgage payment repays some principal, which builds equity without touching cash flow, and property may appreciate, which is the return most buyers are actually counting on and the one nobody can compute in advance. A property with slightly negative cash flow is not automatically a bad investment, and it is a commitment to fund a monthly shortfall out of other income for as long as you hold it.
Income tax and depreciation are absent too, and their effect can be large enough to reverse a comparison between two deals. Depreciation is a deduction against income that involves no cash leaving your hands, and it is recaptured when you sell. Both belong with someone who knows your whole tax position, not with a page that knows twelve numbers about the building.
Questions people ask
What is a good cap rate?
The question has no general answer, because a cap rate is a price, not a grade. Low cap rates cluster in markets where buyers expect rents and values to rise and are willing to accept less current income for it; high cap rates cluster where they are not, which usually means more risk, more vacancy or less growth. Comparing a cap rate against similar properties in the same submarket at the same time is meaningful. Comparing it against a number from a different city or a different year is not, and comparing it against your mortgage rate is meaningful in a narrower way: when the cap rate is below the borrowing rate, leverage reduces your return rather than magnifying it.
Why is the mortgage excluded from NOI and the cap rate?
So that the figure describes the property rather than the buyer. Two purchasers of the same building, one paying cash and one borrowing 80 percent, compute identical NOI and identical cap rate, which is exactly what makes those figures useful for comparing buildings. The moment you subtract a mortgage payment you are measuring a financing decision as well as an asset, and that is cash-on-cash return, which is reported separately here for the same reason.
Should the down payment be my only cash invested?
No, and treating it that way is the most common overstatement of cash-on-cash return. The cash you have committed is the down payment plus closing costs plus whatever the property needed before a tenant could move in, and this calculator adds all three. Leaving out $16,000 of closing and rehab on a $50,000 down payment inflates the return by about a third. If you later refinance and pull cash back out, the denominator changes again, which is why cash-on-cash on a refinanced property has to be recomputed rather than carried forward.
What vacancy rate should I use?
Start from turnover rather than from a market statistic. If tenants stay two years on average and a turnover takes three weeks to re-let and make ready, that is three weeks in every 104, or about 3 percent, and that is the floor for a property in demand with no other problems. Add for a slow local market, seasonal demand or a property that is hard to let. Zero is not a defensible input over any holding period long enough to matter, and this page flags it when you enter it.
Does the 1 percent rule work?
The rule of thumb that monthly rent should be about 1 percent of the purchase price is a screening filter, not a valuation method. It was a reasonable proxy in markets and rate environments where taxes, insurance and financing costs happened to line up so that 1 percent produced positive cash flow, and it silently fails when any of those move — a high property tax jurisdiction can make a property failing the rule perform better than one passing it elsewhere. Use it to decide what to look at more closely, then run the actual expenses, which is what this page is for.