The Numbers You Need to Calculate
Before analyzing a property, gather these figures:
Income:
- Monthly rent or annual rental income
- Parking income (if applicable)
- Utility reimbursements (if applicable)
Expenses:
- Mortgage payment
- Property taxes (annual ÷ 12 for monthly)
- Insurance (annual ÷ 12 for monthly)
- Maintenance and repairs
- Vacancy rate (typically 5-7% of gross income)
- Property management (if applicable)
- Utilities paid by landlord
- HOA fees
- Misc. expenses
Property Details:
- Purchase price
- Down payment amount
- Closing costs
- Total cash invested
1. Cap Rate (Capitalization Rate)
Formula: Net Operating Income ÷ Property Price
NOI = Gross Annual Rent - Annual Operating Expenses (NOT including mortgage)
Example:
- Property price: $150,000
- Monthly rent: $1,200 ($14,400/year)
- Annual property taxes: $1,275
- Annual insurance: $900
- Annual maintenance: $1,500
- Annual vacancy (5%): $720
- Total annual expenses: $4,395
- NOI: $14,400 - $4,395 = $10,005
- Cap rate: $10,005 ÷ $150,000 = 6.67%
Cap Rate Interpretation:
- Below 5%: Poor investment, likely property overpriced
- 5-6%: Acceptable, expect appreciation
- 6-8%: Good, solid cash flow
- 8%+: Excellent, strong cash flow
Indianapolis typically sees 6-8% cap rates. If a property shows 4%, it's overpriced or high appreciation is expected.
2. Cash-on-Cash Return
Formula: Annual Cash Flow ÷ Total Cash Invested
Example (using same property):
- Monthly rent: $1,400 ($16,800/year)
- Annual expenses: $4,395
- NOI: $16,800 - $4,395 = $12,405
- Mortgage: $10,800/year
- Annual cash flow: $12,405 - $10,800 = $1,605
- Down payment: $30,000
- Closing costs: $3,000
- Total invested: $33,000
- Cash-on-cash return: $1,605 ÷ $33,000 = 4.86%
Cash-on-Cash Interpretation:
- Below 5%: Poor return, consider alternatives
- 5-8%: Acceptable, especially with appreciation
- 8%+: Excellent, strong monthly returns
3. Debt Service Coverage Ratio (DSCR)
Formula: Net Operating Income ÷ Total Debt Service
Example:
- NOI: $12,405/year
- Mortgage payment: $10,800/year
- DSCR: $12,405 ÷ $10,800 = 1.15
DSCR Interpretation:
- Below 1.0: Property doesn't cover its debt (negative cash flow)
- 1.0-1.25: Break-even to minimal cash flow
- 1.25+: Good, positive cash flow
Lenders typically want 1.2+ DSCR on investment properties.
4. Return on Investment (ROI)
Formula: (Annual Profit + Annual Appreciation) ÷ Total Investment
Example (assuming 3% annual appreciation):
- Annual cash flow: $1,605
- Property appreciation (3% of $150,000): $4,500
- Total annual return: $1,605 + $4,500 = $6,105
- Total investment: $33,000
- ROI: $6,105 ÷ $33,000 = 18.5%
This is a strong return and justifies the investment.
Red Flags - Don't Buy If:
- Cap rate below 5% (unless expecting major appreciation)
- Monthly rent is less than 1% of property price
- Cash-on-cash return below 4% (unless expecting strong appreciation)
- Property has negative cash flow you can't cover
- DSCR below 1.0 (property can't cover its own debt)
- Seller financing is being offered (usually means property doesn't qualify for traditional financing)
Green Flags - Buy If:
- Cap rate 6%+
- Cash-on-cash return 5%+
- DSCR 1.2+
- Property in appreciating neighborhood
- Strong tenant demand and low vacancy rates
- Owner-occupied or low-maintenance property type
Common Mistakes
Mistake 1: Ignoring Expenses
Budget conservatively: 30-40% of gross rent for expenses. Don't assume you'll do maintenance yourself or that tenants pay utilities.
Mistake 2: Relying Solely on Appreciation
Don't buy negative cash-flow properties hoping for appreciation. You need monthly cash flow to cover expenses.
Mistake 3: Not Running the Numbers
Many investors make decisions on emotion. Run the numbers first.
Mistake 4: Overleveraging
Don't invest 20-25% down on multiple properties simultaneously. Maintain 30%+ down payments.
Mistake 5: Ignoring Neighborhood Trends
Research employment, crime, school ratings, and development. A property might have great numbers today but be in a declining neighborhood.
Quick Takeaways
- Cap rate (NOI ÷ price) should be 6%+ for good investments
- Cash-on-cash return (cash flow ÷ invested) should be 5%+
- DSCR (NOI ÷ debt) should be 1.2+ for positive cash flow
- Budget 30-40% of rent for expenses (don't underestimate)
- ROI combining cash flow + appreciation should be 8%+ annually