Not what a property might be worth someday — what it actually earns and costs today. Here's the framework, with a fully worked example so you can run your own numbers.
A lot of first-time investors evaluate a rental property the way they'd evaluate a home to live in — location, condition, gut feeling. That's a reasonable starting point, but it's not an investment analysis. Before you make an offer, three specific numbers tell you whether a property actually works financially: net operating income, cap rate, and cash-on-cash return. Here's how each one is calculated, and a fully worked example using clearly labeled hypothetical figures — not a projection for any real property.
The first number has to be grounded in comparable listings, not hope. Pull three to five active or recently leased comparable rentals in the same building or immediate area, matched on unit size and condition, and use that range — not the top of it — as your starting monthly rent estimate.
NOI is annual rental income minus operating expenses — and critically, it does not include your mortgage payment. Financing is a separate decision layered on top of the property's own economics. Operating expenses typically include:
Cap rate is NOI divided by purchase price. It's a quick way to compare properties independent of how they're financed — but it says nothing about your actual cash flow once a mortgage is factored in, which is why it's a starting filter, not the final answer.
Worked example (illustrative figures only — not a projection for any specific property): A condo purchased for $700,000, renting for $2,800/month, generates $33,600 in gross annual rent. Estimated annual operating expenses — property tax $4,200, insurance $600, condo fees $4,800, a 5% maintenance reserve ($1,680), and a 3% vacancy allowance ($1,008) — total $12,288. NOI = $33,600 − $12,288 = $21,312. Cap rate = $21,312 ÷ $700,000 = 3.04%.
Cash-on-cash return factors in how the property is actually financed: it's your annual pre-tax cash flow (NOI minus mortgage payments) divided by the total cash you put in (down payment plus closing costs). This is the number that tells you whether the property puts money in your pocket each month or takes it out — and it can look very different from the cap rate.
Continuing the same example: A 20% down payment on $700,000 is $140,000; adding roughly $15,000 in closing costs brings total cash invested to $155,000. The remaining $560,000 is financed — at an illustrative 5% rate over a 25-year amortization, that works out to a monthly payment of approximately $3,274, or $39,284 annually. Annual pre-tax cash flow = $21,312 (NOI) − $39,284 (mortgage) = −$17,972. Cash-on-cash return = −$17,972 ÷ $155,000 = approximately −11.6%.
That negative result isn't a flaw in the math — it's a realistic outcome under current financing costs. A property can carry a perfectly reasonable cap rate and still cost you money every month once real financing is factored in; a larger down payment or lower rate would improve the cash-on-cash number without changing the cap rate at all. Whether it's still worth it depends on factors this framework doesn't capture: expected appreciation, principal paydown building equity over time, and your own tax situation.
NOI, cap rate, and cash-on-cash return describe income and financing — they don't account for appreciation potential, the tax treatment of rental income and expenses (including capital cost allowance), or tenant-related risk. Those factors matter and vary by situation; they're a conversation for your accountant and mortgage broker, not something a general framework can calculate for you.
General frameworks can only go so far — every file is different. Send a few details and get a straight answer, usually within one business day.