Rental Property Calculator

Rental Property Investments

A rental property earns money in two ways: income from tenants and growth in the property's value. Rent pays the mortgage and running costs and, ideally, leaves something over each month. Meanwhile tenants' rent gradually pays down the loan, and the property may appreciate. Together these make real estate one of the most common ways individuals build wealth outside the stock market.

Residential rentals range from a single condo or house to duplexes, small apartment buildings and short-term vacation rentals. Commercial properties such as offices, retail and warehouses follow the same logic but use longer leases and different financing.

Leverage is central to rental investing. Buying a $200,000 property with $40,000 down means every 1% rise in value adds $2,000 of equity, a 5% return on the cash invested before any rent. Leverage works in reverse too, magnifying losses if values fall, and mortgage payments are due whether or not the unit is rented.

Rentals also carry real work and risk. Tenants must be found, screened and managed; repairs come at inconvenient times; vacancies interrupt income; and local laws govern deposits, evictions and habitability. Many owners hire a property manager, typically for 8% to 12% of collected rent, which the management fee field captures.

Taxes matter too. Rental income is taxable, but owners can deduct mortgage interest, property tax, insurance, repairs, management fees and depreciation of the building over 27.5 years for residential property. When the property is sold, gains are taxed, and prior depreciation is recaptured, unless the sale is deferred through a 1031 exchange. The calculator works before income taxes, so treat its returns as pre-tax figures.

General Guidelines

Investors use a few rules of thumb to screen properties quickly before running a full analysis:

• The 1% rule: monthly rent should be at least 1% of the purchase price. A $200,000 property should rent for $2,000 or more. It is a rough filter that is hard to meet in expensive markets.
• The 50% rule: operating expenses, excluding the mortgage, tend to consume about half of gross rent over time. If half the rent will not cover the mortgage payment, the property is unlikely to cash-flow.
• Budget for vacancy and repairs: a 5% to 10% vacancy allowance and 1% or more of the value per year for maintenance are common starting points; older buildings need more.
• Keep reserves: lenders often require six months of payments in reserve for investment properties, and expect larger down payments, commonly 15% to 25%, and slightly higher rates than for a primary home.

Internal Rate of Return

The internal rate of return measures the annual return on the whole investment, accounting for the timing of every cash flow: the initial outlay, each year's cash flow and the proceeds from the sale. Formally it is the discount rate at which the net present value of those flows is zero. IRR lets you compare a rental with other investments of different sizes and holding periods. With the default inputs, the property returns about 18.4% a year over 20 years, well above its year-one cash-on-cash return because rent growth, loan paydown and appreciation all add to the total.

Capitalization Rate

The capitalization rate, or cap rate, is a property's net operating income divided by its value. Because it ignores financing, it compares properties on equal terms regardless of how they are bought. With the defaults, year-one rent collected is $22,800 after 5% vacancy and operating expenses are $6,700, for a net operating income of $16,100 and a cap rate of 8.05% on the $200,000 price.

Higher cap rates mean more income per dollar of price, but often come with more risk, such as weaker locations or older buildings. Typical cap rates for residential rentals in many U.S. markets fall between about 4% and 10%.

Cap rate = NOI ÷ property value · Cash on cash = annual cash flow ÷ cash invested

NOI

net operating income: rent collected after vacancy minus operating expenses, before mortgage payments

cash flow

NOI minus mortgage payments

cash invested

down payment plus closing and repair costs

IRR is the annual rate that makes the present value of all cash flows, from the initial investment through yearly cash flow to the sale proceeds, equal zero.

Cash Flow Return on Investment

Cash-on-cash return divides a year's cash flow after mortgage payments by the cash you put in. It shows how hard your own money is working in a given year, which matters to investors who rely on rental income. With the defaults, $46,000 invested produces about $4,589 of cash flow in year one, a cash-on-cash return near 10%.

Things to Keep in Mind

Projections are only as good as their inputs. Rent growth, appreciation and expense increases rarely move in a straight line, and a few vacant months or a major repair can erase a year's cash flow. Try conservative scenarios, such as 1% appreciation, a higher vacancy rate and a management fee, to see how sensitive the result is.

Check local rules on rental licensing, rent control and short-term rentals, confirm insurance costs for a non-owner-occupied property, and inspect the building carefully. Finally, remember that real estate is illiquid: selling takes months and costs several percent of the price, so plan to hold long enough to recover those costs.

Other Types of Real Estate Investments

Owning rentals directly is not the only way to invest in property.

• Real estate investment trusts (REITs) are companies that own or finance income-producing property and trade like stocks. They must pay out most of their taxable income as dividends and offer diversification and liquidity with no landlord duties.
• Real estate mutual funds and ETFs hold baskets of REITs and real estate companies for even broader diversification.
• Crowdfunding platforms pool money from many investors to fund specific projects or loans, often with high minimums and limited liquidity.
• House flipping means buying, renovating and reselling quickly for a profit. Returns depend on accurate repair estimates and a strong market, and profits are taxed as ordinary income when held under a year.
• Short-term and vacation rentals can earn more per night but have higher turnover, cleaning and management costs and are increasingly regulated.
• Commercial property and land offer different risk and return profiles, usually with larger capital requirements and more specialized knowledge.

Frequently asked questions

Sources

• IRS Publication 527 – Residential Rental Property
• IRS – Like-kind exchanges (Section 1031)
• SEC Investor.gov – Real estate investment trusts