Cash flow is what is left after everything
The arithmetic is short: effective rent, minus operating expenses, minus the mortgage. What makes it go wrong is almost never the maths. It is the expenses people leave out.
A property that looks like it clears $600 a month on rent minus mortgage usually clears far less once vacancy, management, maintenance and capital reserves are in the model. Those four are not optional costs you might avoid — they are certainties whose timing is unknown. A roof you replace once in twenty years is still an expense you incur every month; you simply pay it in a lump at the end.
The expenses most models miss
- Vacancy — 5 to 10 per cent depending on market and tenant quality. Turnover also brings cleaning, repainting and listing costs.
- Management — typically 8 to 10 per cent of collected rent, plus a placement fee. Include it even if you self-manage, because your time has value and you may not always want the job.
- Maintenance — routine repairs, call-outs, the things that break.
- Capital reserves — roof, HVAC, water heater, flooring. Older properties need a larger allowance than newer ones.
Cash-on-cash return
Annual cash flow divided by the cash you actually put in — down payment plus closing costs plus rehab. It answers a narrow but useful question: what is this deal paying on the money I tied up?
Because it counts only cash returns, it deliberately ignores the other three ways rental property makes money: principal paydown by the tenant, appreciation, and depreciation's tax shelter. A deal with modest cash-on-cash return can still be a strong total return. Equally, cash-on-cash is the only one of the four you can spend, and a property with negative cash flow needs feeding from your income every month regardless of how the other three look on paper.
On the 1% and 50% rules
Both are screening heuristics from an era of cheaper property, and neither should decide anything.
The 1% rule — monthly rent of at least 1 per cent of price — has become unreachable in most coastal and high-appreciation markets. Properties clearing it today tend to be in markets where the trade-off is weaker appreciation and higher management burden.
The 50% rule is the more useful of the two, precisely because it works as a sanity check on your own inputs. If your operating expenses come out far below half of gross rent, the likely explanation is not that you have found an unusually cheap property but that something is missing from the list.
Common questions
What counts as good cash flow?
There is no universal figure, and per-door targets like $100 or $200 a month ignore how much capital is tied up. Cash-on-cash return is the more comparable measure, since it accounts for what you actually invested. Judge it against what the same money would earn elsewhere at similar risk.
Should I include management if I self-manage?
Yes. Self-managing is a job you are choosing to do unpaid, and it is a job you may want to stop doing later. If the deal only works because you are working for free, it does not work — and it certainly will not work for whoever buys it from you.
How much should I budget for capital reserves?
Commonly 5 to 10 per cent of gross rent, scaled to the age and condition of the property. A newly renovated house needs less than a 1960s original. If you know the remaining life of the roof and HVAC, budget from replacement cost divided by years remaining rather than a percentage.
Does cash-on-cash return include appreciation?
No, and that is by design. Cash-on-cash covers cash returns only. Total return would add principal paydown, appreciation and tax benefits, but those are unrealised until you sell or refinance, and appreciation in particular is a forecast rather than a fact.
Why is my cash flow negative with 25 per cent down?
In most cases the rent-to-price ratio in that market simply does not support current interest rates. The levers are a larger down payment, a cheaper property, higher rent, or a different market. Buying negative cash flow on the expectation of appreciation is a bet, not an income investment — which is a legitimate strategy, but worth naming honestly.