How to Know If a Rental Will Cash Flow Before You Buy
You found a property. The listing photos look decent, the neighborhood seems fine, and the agent keeps saying "this one won't last." Before you write an offer, you need one number: will the rent cover everything the property costs to own, with money left over. Here's how to find that number in the next twenty minutes.
The Short Answer
Cash flow is monthly rent minus every recurring cost of owning the property. Not just the mortgage. Add up the mortgage payment (principal and interest), property taxes, insurance, an estimate for vacancy, an estimate for repairs, an estimate for capital expenses like a new roof or water heater someday, and property management if you're not doing it yourself. Subtract that total from the rent you can realistically collect. If the number left over is positive, you have cash flow. If it's negative, you're paying to own a rental, not the other way around.
Most people only run the mortgage against the rent. That's the mistake. It makes almost any deal look good, which is exactly why so many first-time landlords end up underwater the first time a furnace dies.
Why the Mortgage Alone Lies to You
A $1,200 mortgage payment against $1,800 in rent looks like $600 a month in profit. It isn't. That $600 has to survive property taxes, insurance, the month the tenant moves out and it sits empty, the plumber, the new dishwasher, and eventually a roof. Skip those categories and you're not underwriting a rental, you're guessing.
Taxes and insurance you can get exact numbers for before you buy. Call the county assessor's office or look up the parcel online for the current tax bill. Call an insurance agent and get an actual quote for that specific address. These are not estimates you should be rounding in your head.
Vacancy, repairs, capital expenses, and management are the ones people skip because they're not on the closing disclosure. That's exactly why they're the ones that sink deals. A property doesn't rent to a new tenant the same day the old one leaves. Appliances break. A roof that's fine today is not fine in year twelve. Budget for these even when nothing is broken yet, because eventually something will be.
The Formula, Written Out
Monthly cash flow = Rent − (Mortgage P&I + Taxes + Insurance + Vacancy + Repairs + CapEx + Management)
Estimate the variable categories as a percentage of rent if you don't have property-specific history:
- Vacancy: 5% of rent
- Repairs and maintenance: 5% of rent
- CapEx reserve: 5% of rent
- Property management: 8-10% of rent, even if you plan to self-manage. If you ever hire it out, or if you get hit by a bus and someone else has to run the property for a few months, the number needs to already be in the budget.
These percentages aren't guarantees of what you'll spend in any given month. They're reserves. Some months you spend zero on repairs. Some months a water heater costs you $1,400. The percentage smooths it out over a year so one bad month doesn't wipe out your plan.
A Worked Example
Say you're looking at a single-family rental listed at $220,000. You'll put 20% down, so $44,000, financing $176,000 at 7% over 30 years. Market rent for that property, based on three comparable listings you actually pulled, is $2,100 a month.
Here's the monthly math:
- Principal and interest on $176,000 at 7%: $1,170
- Property taxes (pulled from the county site, 1.2% of value annually): $220
- Insurance (actual quote from an agent): $110
- Vacancy (5% of $2,100): $105
- Repairs and maintenance (5% of $2,100): $105
- CapEx reserve (5% of $2,100): $105
- Property management (8% of $2,100): $168
Total monthly cost: $1,170 + $220 + $110 + $105 + $105 + $105 + $168 = $1,983
Rent minus total cost: $2,100 − $1,983 = $117 a month
That's $1,404 a year in cash flow on $44,000 down, before accounting for the tenant paying down your loan balance and whatever the property appreciates. That's a real number, but it's thin. One slightly-below-average month of maintenance and you're at zero. This is the kind of deal you negotiate harder on, not the kind you get excited about from the listing photos.
What People Get Wrong
The biggest error is using the 1% rule as a final answer instead of a first screen. The 1% rule says monthly rent should be at least 1% of purchase price, so a $220,000 property should rent for $2,200. It's a fast way to rule properties out. It is not a substitute for actually running the numbers, because it ignores your specific interest rate, your specific tax bill, and your specific insurance quote, all of which move the real number a lot.
The second error is using pro forma rent instead of comparable rent. Pro forma rent is what the listing agent says the property "could rent for." Comparable rent is what three or four similar units within a mile are actually renting for right now, checked yourself. Use the second one. The first one is a sales tool.
The third error is guessing at insurance instead of quoting it. Insurance costs vary enormously by property age, roof condition, and location, especially in states dealing with wildfire or flood risk right now. A guess that's off by $100 a month turns a cash-flowing deal into a losing one on paper alone.
The One Thing This Math Doesn't Tell You
Cash flow math tells you whether the numbers work on the day you buy, based on the assumptions you plugged in. It does not protect you from a bad tenant, a bad property manager, a rent estimate that turns out to be optimistic, or a repair that's bigger than your reserve. Two properties can run the identical spreadsheet and produce very different years, because the spreadsheet assumes averages and real life doesn't happen in averages. Run the numbers to rule out the deals that never had a chance. Don't mistake a good spreadsheet for a guarantee.
Where to Go From Here
Running this math by hand on every property you're considering gets old fast, especially if you're comparing five or six listings a week. Deal Machine at readmoneydecoded.com/deal-machine runs this exact calculation for you, using the property's actual tax and insurance figures instead of rough guesses, so you can see the real number before you're three weeks into a contract.