How to Calculate Rental Property ROI Before You Buy
Let's say you want to buy a house for $200,000 and rent it out for $1,500 a month. That sounds like $18,000 a year in income, right? Not quite. A lot of new investors get burned because they stop the math right there. Here's how to run the full picture before you make an offer.
Your Real Income Is Lower Than You Think
That $1,500 in rent doesn't all land in your pocket. Here's what actually happens to it:
Start with $1,500 rent. Subtract 8% vacancy (units sit empty sometimes, budget for it): $1,500 x 0.92 = $1,380. Subtract 10% for a property manager if you hire one: $1,380 x 0.90 = $1,242. You're already at $1,242 before a single expense hits. That's your effective monthly income to work with.
Now Add Up the Expenses
- Mortgage payment: On a $160,000 loan (20% down on a $200k home) at 7%, that's about $1,065 a month.
- Property taxes and insurance: Add roughly $250 to $350 a month depending on location. Use $300 as a baseline estimate.
- Maintenance: Budget 1% of the home's value per year. On a $200,000 home, that's $2,000 a year, about $167 a month.
- CapEx reserves: The roof, HVAC, and water heater will eventually need replacing. Set aside $100 to $150 a month so big repairs don't blindside you.
Total monthly expenses: $1,065 + $300 + $167 + $125 = $1,657. Effective monthly income: $1,242. That's negative $415 a month. The property is costing you money every month, not making you money. This is exactly how new investors get surprised. Run the full math before you fall in love with a property.
So How Do You Find a Good Deal?
You need higher rent, a lower purchase price, or both. A quick filter is the 1% rule: monthly rent should be at least 1% of the purchase price. On a $200,000 home, that means $2,000 a month in rent. If your market can't support that, the numbers will be very hard to make work.
Cash-on-Cash Return
This is the number serious investors track. Take your annual cash flow (what's left after all expenses) and divide it by the total cash you put in, meaning your down payment plus closing costs.
You invest $50,000 total (down payment + closing costs). After all expenses, you clear $300 a month, or $3,600 a year. $3,600 divided by $50,000 = 7.2% cash-on-cash return. That's solid. Below 5% and you might want to keep looking. Below 0% and the deal needs a serious rethink.
Use the ROI Analysis tab to plug in rent, expenses, vacancy, and management fees. See your real cash-on-cash return before making an offer.