What is a good cap rate for a rental property?

For small multifamily properties (2–4 units), a cap rate of 5–8% is generally considered solid. In high-cost urban markets, 4–5% is more typical. Higher cap rates indicate higher yield but often come with higher risk — older properties, less desirable locations, or more management-intensive situations.

The 1% rule is a quick filter: monthly rent should equal at least 1% of the purchase price. A $200,000 property should rent for at least $2,000/month. It is a useful screening tool but not a substitute for full analysis — it does not account for operating expenses, taxes, or financing.

What is the difference between cap rate and cash-on-cash return?

Cap rate ignores financing — it measures the property's return as if you paid cash. Cash-on-cash return accounts for your actual mortgage payments and measures the return on the cash you personally invested. For leveraged buyers, cash-on-cash is the more relevant number.

Should I include mortgage payments in my operating expenses?

No. Mortgage payments are a financing cost, not an operating expense. Cap rate is calculated before financing. You account for your mortgage when calculating cash flow and cash-on-cash return.

What expenses do first-time landlords commonly forget?

Capital expenditure reserves (saving for roof, HVAC, appliance replacement), vacancy allowance, and landlord insurance. Many beginners only budget for mortgage, taxes, and insurance — and get surprised when a water heater fails.

How to Tell If a Rental Property Will Make Money Before You Buy

Most people skip the math when they buy their first rental property. That’s how they end up with a deal that looks good on paper and bleeds money in real life. Do the analysis before you make an offer - not after.

What you’ll learn:

The two numbers every rental property buyer needs to calculate
How to build a deal analysis from scratch, step by step
A worked example using a real duplex scenario
How to stress test a deal before you commit

What are the two most important numbers in rental property analysis?

Cap rate and cash-on-cash return - and you need both. Cap rate measures the property’s income potential independent of how you finance it. Cash-on-cash return measures the return on the actual cash you put in, given your specific loan terms. One without the other gives you an incomplete picture.

Understanding the difference between them is what separates careful buyers from people who get burned.

Step 1: Calculate Gross Rental Income

Start with what the property actually rents for today - not what the seller claims, not what it rented for three years ago, not what you hope to get. Check current comparable rentals on Zillow, Apartments.com, and Facebook Marketplace for your target zip code. That’s your market rent.

Add up the annual rent from all units at 100% occupancy.

Example: A duplex with two units at $1,400/month = $33,600 gross annual income.

Step 2: Apply a Vacancy Factor

No property runs at 100% occupancy all year, every year. Budget 5-8% for vacancy, credit loss, and non-payment. This is not pessimism - it’s accurate underwriting.

Example: $33,600 × 0.93 = $31,248 effective gross income.

Step 3: Calculate Operating Expenses - and don’t miss these

This is where most first-time buyers undercount. Operating expenses include all of the following:

Property taxes (get the actual bill from the county assessor’s website - don’t guess)
Landlord insurance (typically $1,000-$2,500/year for a small multifamily)
Maintenance (budget 1% of property value per year - on a $350,000 property, that’s $3,500)
Capital expenditure reserve (separate from maintenance - this is saving for roof, HVAC, appliances)
Property management (8-12% of collected rent if you use a manager)
Utilities you pay (water, trash, common area electric - verify which are owner-paid)
HOA fees (if applicable)

Do not include your mortgage payment here. That’s a financing cost, not an operating expense. It comes in later.

Example: Taxes $4,200 + Insurance $1,800 + Maintenance $3,500 + CapEx Reserve $2,500 = $12,000 operating expenses.

Step 4: Calculate Net Operating Income (NOI)

NOI = Effective Gross Income - Operating Expenses

Example: $31,248 - $12,000 = $19,248 NOI.

NOI is the property’s earning power before debt service. It’s what you use to compare properties side by side, independent of how either one is financed.

Step 5: Calculate Cap Rate

Cap Rate = (NOI ÷ Purchase Price) × 100

Example: ($19,248 ÷ $350,000) × 100 = 5.5% cap rate.

A 5.5% cap rate on a duplex is solid in most markets. In high-cost cities, 4-5% is typical. In lower-cost markets, 7-9% is achievable. A higher cap rate means more income relative to price - but it often comes with higher risk: older buildings, more maintenance, less desirable locations. Don’t chase cap rate alone.

Step 6: Calculate Cash-on-Cash Return

Now bring in your actual financing.

Annual Cash Flow = NOI - Annual Mortgage Payments

Cash-on-Cash Return = Annual Cash Flow ÷ Total Cash Invested

Example: 25% down payment ($87,500) on a $350,000 property, 7% interest, 30-year fixed. Annual mortgage payments: approximately $20,940.

Annual Cash Flow: $19,248 - $20,940 = -$1,692.

This deal loses money on a cash flow basis at current rates. That doesn’t automatically make it a bad deal - equity is building and appreciation may come - but you should know this before you buy, not after. To make it cash flow, you’d need a lower purchase price, higher rents, a lower rate, or some combination.

Step 7: Stress test before you commit

Run the numbers one more time - this time assume one unit vacant for two months and a $4,000 surprise repair. If the deal still roughly holds together, you have enough margin. If it falls apart under mild stress, the margin is too thin. Walk away.

How do I use the 1% rule?

The 1% rule is a 10-second screening tool, not a substitute for full analysis. Monthly rent should equal at least 1% of the purchase price. A $300,000 property should rent for at least $3,000/month.

In most high-cost markets, hitting 1% is nearly impossible - which is exactly why cash flow is so hard to find there. If a property fails the 1% rule badly, move on. If it passes, run the full numbers above.

What does a good deal actually look like?

For a first small multifamily property, reasonable targets are:

Cap rate: 5-8%
Cash-on-cash return: 6-10% (or at least breakeven in expensive markets where appreciation is reliable)
Cash flow: ideally $200-$400 per unit per month after all expenses and debt service

If a deal doesn’t hit these, you don’t have to walk away - but you need to know exactly what you’re betting on and why.