Rent Minus Mortgage Is Not Profit
The most expensive mistake in rental investing is the simplest one: seeing $2,200 rent against a $1,500 mortgage payment and calling it $700/month profit. That math ignores vacancy, maintenance, capital expenditures, management, insurance, and taxes — the line items that decide whether a property builds wealth or bleeds it.
Serious investors evaluate every deal with the same handful of metrics. Here they are, with the honest version of the math.
Start With True Operating Expenses
Before any metric, list what the property actually costs to operate, whether or not each item bills you monthly:
- Vacancy (5–8% of rent) — tenants leave; units sit empty between leases
- Maintenance (~1% of property value per year) — the drip of repairs
- Capital expenditures — reserves for the roof, HVAC, and water heater that will absolutely fail on your watch
- Property management (8–10% of rent) — count it even if you self-manage; your time isn't free, and you may not always want the 2 a.m. calls
- Property taxes and insurance — and both trend upward
- HOA dues, utilities, lawn/snow where applicable
A property that only works at 100% occupancy with zero repairs doesn't work.
The Four Metrics
1. Net Operating Income (NOI) — annual rent minus all operating expenses, excluding the mortgage. This is what the property itself earns, independent of how you financed it.
2. Cap rate = NOI ÷ purchase price. The property's unleveraged return, and the standard way to compare properties. Context matters: 4–6% is typical for desirable low-risk markets; 8%+ usually signals higher risk, rougher neighborhoods, or heavy management burden. Compare within a market, not across markets.
3. Cash flow = NOI − mortgage payment. What actually lands in (or leaves) your pocket each month.
4. Cash-on-cash return = annual cash flow ÷ total cash invested (down payment + closing costs + initial repairs). This measures the return on the money you personally put in — the number to compare against what that cash could earn elsewhere.
A Worked Example, Honestly
A $250,000 single-family rental renting for $2,200/month, bought with 20% down ($50,000) plus $7,500 in closing costs and initial repairs — $57,500 cash invested, financing $200,000 at 6.5%:
| Monthly item | Amount |
|---|---|
| Rent | $2,200 |
| Vacancy (5%) | −$110 |
| Management (8%) | −$176 |
| Maintenance + capex reserve | −$225 |
| Property tax | −$250 |
| Insurance | −$100 |
| NOI | $1,339 |
| Mortgage (P&I) | −$1,264 |
| Cash flow | $75/month |
Cap rate: $16,068 ÷ $250,000 ≈ 6.4%. Cash-on-cash: $900 ÷ $57,500 ≈ 1.6%.
That cash flow is thin — one furnace ends the year negative. And that's the honest state of many markets: at today's prices and rates, monthly cash flow alone rarely justifies the deal.
So Where Does the Wealth Come From?
Rentals build wealth through four streams at once, and cash flow is usually the smallest early on:
- Cash flow — modest at first, but it grows as rents rise against a fixed mortgage payment
- Principal paydown — your tenant retires your loan; on the example above, roughly $2,300 of equity in year one, accelerating every year
- Appreciation — at a conservative 3%/year, the $250,000 property gains $7,500 in year one, and you captured it with $57,500 of invested cash (leverage works both directions — this is also the risk)
- Tax treatment — depreciation deductions often shelter much of the cash flow from income tax (details for a tax professional)
Summed over a decade, an unremarkable-looking property can meaningfully outperform what the same cash earned elsewhere — or underperform badly if bought on wishful math. The difference is the expense honesty above.
About the 1% Rule
The old screen — monthly rent should be at least 1% of purchase price — would demand $2,500 rent on our $250,000 example, which fails at $2,200. In most desirable markets today, nearly everything fails the 1% rule. Use it as a quick sorting heuristic when scanning listings, not a verdict; the full analysis is the verdict.
Key Takeaway
Underwrite every deal with real expenses — vacancy, capex, and management included — then judge it on cap rate, cash flow, and cash-on-cash return plus principal paydown and conservative appreciation. If a property only pencils out with optimistic numbers, it doesn't pencil out. Run the full ten-year picture before you write an offer.