The real return on a rental property is what you earn on the cash you put in, after every cost. Start with rent, subtract vacancy, property tax, insurance, maintenance, management and other running costs to get net operating income. Divide it by the price for the cap rate. Subtract the mortgage payment and divide by your cash invested for cash-on-cash return. Add principal paid and appreciation for total return. At 2026 mortgage rates, many rentals have negative cash flow even when they look profitable.
Three numbers, three questions
A rental property has more than one "return", and each answers a different question.
- Cap rate = net operating income ÷ property price. How good is the property itself, ignoring financing?
- Cash-on-cash return = annual cash flow after the mortgage ÷ cash you invested. What does your money earn this year?
- Total return = cash flow + mortgage principal paid + appreciation, divided by cash invested. How fast is your equity growing?
Net operating income (NOI) is rent actually collected minus all running costs — but not the mortgage. The mortgage is financing, not an operating cost.
A worked example
A $400,000 property bought with 25% down ($100,000) plus $12,000 of closing costs, so $112,000 of your own cash. The $300,000 mortgage is a 30-year fixed loan at 7.32%, the Freddie Mac average on October 22, 2026. Rent is $2,800 a month.
| Item | Per year |
|---|---|
| Rent ($2,800 × 12) | $33,600 |
| Vacancy (7.3%) | −$2,453 |
| Rent collected | $31,147 |
| Property tax | −$5,200 |
| Insurance | −$2,400 |
| Maintenance (1% of value) | −$4,000 |
| Management (8% of rent collected) | −$2,492 |
| HOA, utilities, other | −$1,200 |
| Net operating income | $15,855 |
| Mortgage payments ($2,061 × 12) | −$24,730 |
| Cash flow | −$8,875 |
- Cap rate: $15,855 ÷ $400,000 = 3.96%.
- Cash-on-cash: −$8,875 ÷ $112,000 = −7.9%. You pay in every month.
- Total return, year one: −$8,875 cash flow + $2,864 principal paid + $12,000 appreciation (if the price rises 3%) = $5,989, or 5.3% on $112,000 — and only if the appreciation actually happens.
The vacancy figure is the US rental vacancy rate for the second quarter of 2026 from the Census Bureau. The other costs are illustrative; use your own numbers.
Leverage cuts both ways
A mortgage multiplies your equity gains when prices rise, and your losses when they fall. When the mortgage rate is above the cap rate — 7.32% against 3.96% in the example — borrowed money costs more than the property earns, and cash flow turns negative. The deal then depends on appreciation and rent growth.
That is not automatically a bad investment, but it is a different one: you are buying future growth and paying for it monthly. Make sure you have the liquid reserves to cover the shortfall for years, not months.
Taxes
In the US, rental income is taxable, but you can deduct operating expenses and mortgage interest, and you can depreciate a residential building (not the land) over 27.5 years. Depreciation often turns a positive cash flow into a lower taxable income. When you sell, depreciation you have claimed is generally recaptured. Other countries have different rules; check them with a local tax adviser.
Common mistakes
- Calling rent minus mortgage "profit". It ignores every other cost.
- Using the price instead of your cash. Return on equity is what you earn on your money.
- Assuming 100% occupancy. Nothing is rented every day of every year.
- Counting appreciation as income. It is real only when you sell or refinance.
- Not comparing alternatives. A 5% total return with risk and work should be compared with what the same $112,000 would earn elsewhere.
How to do it in AOS
When to recalculate
Recalculate every year with real numbers from your records, and whenever something changes: a new tenant, a rent increase, a tax reassessment, a refinance. The first-year estimate is a forecast; the yearly P&L is the truth.
FAQ
What is a good cap rate?
It depends on the market and the property type. Lower cap rates are typical where prices are high and demand is stable; higher ones usually come with more risk. Compare a property with similar ones in the same area, and with your mortgage rate.
What is a good cash-on-cash return?
Many investors look for a positive figure that beats safer alternatives. At today's mortgage rates, a positive cash-on-cash return often requires a larger down payment or a lower price.
Should I include appreciation in my return?
Show it separately. Cash flow and principal paid are measurable every year; appreciation is an estimate until you sell.
Is the 1% rule useful?
The rule that monthly rent should be at least 1% of the price is a quick filter, not a calculation. In the example, $2,800 on $400,000 is 0.7% — and the full calculation explains why the cash flow is negative.
Should I pay cash instead of using a mortgage?
Without a loan, the example's cash flow equals NOI: $15,855 a year, about 3.8% on a $412,000 outlay. You remove the negative cash flow, but you also tie up far more capital. Compare both with your other options.
Sources
This article is for information only and is not investment, tax or legal advice. Figures are given with their source and date.
