What is cap rate and why does it matter?
Cap rate (capitalization rate) equals annual NOI divided by property price, expressed as a percentage. It measures how much annual income you generate per dollar of property value. Higher cap rates (6-8%+) suggest stronger cash flow and faster payback, while lower cap rates (3-5%) imply appreciation-driven investments or overpriced properties. Use cap rate to compare properties and ensure you're not overpaying relative to the income generated.
What's the difference between cap rate and cash-on-cash return?
Cap rate uses the total purchase price as the denominator, while cash-on-cash uses only your cash down payment. Example: $300k property, $60k down, $18k annual NOI. Cap rate = 18k/300k = 6%. Cash-on-cash = 18k/60k = 30%. Cash-on-cash is higher because you're measuring return only on money you actually invested, but cap rate better compares properties of different prices.
Should I aim for positive or negative cash flow?
Positive cash flow is almost always better. Negative cash flow means you pay out of pocket each month and your returns depend entirely on appreciation. Positive cash flow provides income now, reduces your risk, and funds repairs. The exception: newly developed or appreciating markets where long-term capital gains outweigh current cash flow, but this requires strong reserves and risk tolerance.
What operating expenses should I include?
Include property taxes, homeowner insurance, landlord insurance, HOA fees (if applicable), vacancy allowance (5-10% of rent), property management (8-12% if you hire a manager), maintenance and repairs (5-10% of rent), utilities you cover, and pest control. Do NOT include mortgage principal (that's not an expense; it builds equity) or your mortgage interest (separate line item if modeling after-tax returns).
How do I estimate monthly rent for a property I don't own yet?
Research comparable rentals ('comps') on Zillow, Apartments.com, Craigslist, and local property management sites for the same neighborhood, property type, and condition. Call local property managers to ask typical rents in the area. Survey recent rent increases (typically 2-4% annually). Be conservative; it's better to underestimate rent and be pleasantly surprised than overestimate and lose money. Run several scenarios: base case, pessimistic (10% lower), and optimistic (10% higher).
Does this calculator account for taxes and depreciation?
No—this calculator shows pre-tax cash flow. The actual cash available after income taxes is lower. Depreciation is a non-cash tax deduction that reduces taxable income, often making investment properties tax-advantaged. Mortgage interest is tax-deductible. Consult a tax professional or accountant to model after-tax cash flow, which is the true metric for your personal decision.
How does refinancing or a changing interest rate affect my analysis?
This calculator assumes a fixed interest rate for the full term. In reality, ARM (adjustable rate mortgages) can reset to higher rates, crushing cash flow. Always use fixed-rate mortgages for investment analysis unless you plan to refinance or sell quickly. Model what happens if rates rise 1-2%; if cash flow stays positive, you're safer. If cash flow turns negative, the investment becomes risky.
Should I use appreciation in my decision?
Appreciation is a bonus, not a guarantee. Never invest based primarily on future appreciation; it's speculative. Focus on cash flow and cap rate, which are under your control. Appreciation (typically 2-4% annually) is the cherry on top. Use this calculator to ensure the property works financially today; appreciation makes it better over time, but shouldn't be your primary motivation.
What's a good cap rate?
It depends on your market and risk tolerance. A cap rate of 6-8% is generally considered strong, indicating reliable cash flow. A cap rate of 4-6% is moderate, often seen in appreciating or low-risk markets. A cap rate below 4% suggests high prices or tight margins. Compare cap rates in your target market to local averages; if a property is 2-3% below market cap rate, it's likely overpriced.
How do vacancies affect my calculation?
This calculator uses the full monthly rent amount. In reality, properties often sit vacant between tenants (typically 5-10% of the year), especially in softer markets. Reduce your expected monthly rent by 5-10% to account for vacancy losses, or set aside a separate 'vacancy reserve.' This keeps your projections realistic and prepares you for gaps in tenancy.