Rental properties can generate recurring income, but that income is not entirely passive. Investors must account for vacancies, repairs, management, financing costs, and other expenses when evaluating a potential acquisition.
A consistent underwriting process can help investors compare opportunities, establish realistic expectations, and identify properties that may not support their investment goals.
Rental property cash flow is the income remaining after operating expenses and debt payments have been paid:
Cash Flow = Rental Income − Vacancy and Credit Loss − Operating Expenses − Debt Service
Consider an investor purchasing a property for $250,000 with expected monthly rent of $2,400.
Start with the property’s gross scheduled rent and subtract expected vacancy and uncollected rent.
Investors should use market-supported rent and vacancy assumptions rather than relying exclusively on the seller’s projections or the property’s current occupancy.
Operating expenses generally include costs required to own and operate the property, excluding mortgage payments and income taxes.
For this example:
Subtracting operating expenses from effective rental income produces the property’s net operating income:
NOI = $27,360 − $9,504 = $17,856
Expenses vary significantly by property and market. Investors should verify taxes, insurance, utilities, management costs, maintenance needs, and any association fees before purchasing.
Assume the investor obtains a $187,500 loan—75% of the purchase price—with a 30-year amortization schedule. Using an illustrative 7% interest rate, annual principal and interest payments would be approximately $14,970.
Actual payments will depend on the interest rate, loan structure, amortization, and applicable fees.
Subtract annual debt service from NOI:
Annual Cash Flow = $17,856 − $14,970 = $2,886
This represents estimated pre-tax cash flow before income taxes and unexpected expenditures.
Cash flow is important, but investors typically use several metrics to evaluate a property.
DSCR measures whether property income can support its debt payments:
DSCR = NOI ÷ Annual Debt Service
In this example:
DSCR = $17,856 ÷ $14,970 = 1.19x
A 1.19x DSCR means the property generates approximately $1.19 of NOI for every $1 of debt service. A higher DSCR generally provides a larger cushion for vacancies or expense increases.
Lenders may calculate income and expenses differently and establish their own minimum DSCR requirements.
Cash-on-cash return measures annual pre-tax cash flow relative to the investor’s total cash contribution:
Cash-on-Cash Return = Annual Pre-Tax Cash Flow ÷ Total Cash Invested
Assuming a $62,500 down payment and excluding closing costs:
Cash-on-Cash Return = $2,886 ÷ $62,500 = 4.6%
A complete calculation should also include closing costs, renovation expenses, lender fees, and other initial cash contributions.
The 1% rule compares monthly rent with the purchase price:
Monthly Rent ÷ Purchase Price
For this property:
$2,400 ÷ $250,000 = 0.96%
The property falls slightly below the 1% benchmark. However, this rule does not account for taxes, insurance, financing, condition, appreciation potential, or local operating costs. It should be used only as an initial screening tool.
The 50% rule assumes that operating expenses may consume approximately half of a property’s gross rental income before debt service.
This is also a rough screening tool—not a substitute for property-level underwriting. Actual expenses can vary substantially based on location, age, condition, insurance costs, taxes, utilities, and management requirements.
No single metric determines whether a rental property is a good investment. Investors should evaluate cash flow, DSCR, cash-on-cash return, property condition, market fundamentals, financing costs, and their intended holding period together.
CoreVest offers DSCR rental loans based primarily on the property’s rental income and cash flow. Contact our team to discuss financing for a single rental property or portfolio.
This article is provided for informational purposes only and does not constitute tax, accounting, investment, financial, real estate, or lending advice. Calculations are illustrative, and actual results will vary. All loans are subject to underwriting, credit approval, eligibility requirements, and applicable terms and conditions.
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