Buying a rental property on gut feeling is how investors end up with negative cash flow and regret. Every successful rental portfolio is built on disciplined underwriting — calculating the same core metrics on every deal, every time, before making an offer.
Here are the 10 metrics that matter most, each with its formula, how to interpret it, and a worked example using the same property.
The Sample Property
We'll use this property for all examples:
- Purchase price: $320,000
- Down payment: $64,000 (20%)
- Loan amount: $256,000 at 7% for 30 years
- Monthly payment (P&I): $1,703
- Monthly gross rent: $2,400 ($28,800/year)
- Annual operating expenses: $8,400 (taxes $3,000, insurance $1,200, maintenance $2,400, vacancy/mgmt $1,800)
1. Gross Rental Yield
Formula: Annual Gross Rent ÷ Purchase Price × 100
Example: $28,800 ÷ $320,000 × 100 = 9.0%
Gross yield is a quick, rough filter. It ignores expenses entirely, so it's only useful for comparing similar properties in similar markets. Generally, aim for 8%+ in most markets.
2. The 1% Rule
Formula: Monthly Rent ≥ 1% of Purchase Price
Example: $2,400 ÷ $320,000 = 0.75% — fails the 1% rule
The 1% rule is a screening heuristic, not a decision-maker. In most appreciating markets (coastal cities, suburban metros), 1% is nearly impossible to achieve. This property failing the 1% rule doesn't make it a bad investment — it means you need to evaluate the other metrics carefully.
3. The 2% Rule
Formula: Monthly Rent ≥ 2% of Purchase Price
Example: $2,400 ÷ $320,000 = 0.75% — fails the 2% rule
The 2% rule is reserved for high-yield, high-cash-flow markets (midwest, southeast, rust belt). Properties that hit 2% typically have lower appreciation potential and may require more management intensity. If you're finding 2% deals regularly, scrutinize why.
4. Net Operating Income (NOI)
Formula: Gross Annual Rent − Operating Expenses (does NOT include mortgage payments)
Example: $28,800 − $8,400 = $20,400/year
NOI is the property's income independent of how it's financed. It's the universal metric for comparing properties regardless of leverage. All professional real estate valuation starts with NOI.
5. Cap Rate (Capitalization Rate)
Formula: NOI ÷ Property Value × 100
Example: $20,400 ÷ $320,000 × 100 = 6.4%
Cap rate tells you what return you'd get if you bought the property with all cash. It's a property-level metric used to compare returns across markets and asset classes. Cap rates vary significantly by market:
- Gateway cities (NYC, LA, SF): 3–5%
- Secondary markets: 5–7%
- Tertiary markets: 7–10%+
A 6.4% cap rate in a secondary market is solid. In NYC, it would be exceptional.
6. Cash-on-Cash Return
Formula: Annual Pre-Tax Cash Flow ÷ Total Cash Invested × 100
First, calculate annual cash flow:
- Annual NOI: $20,400
- Annual mortgage payments: $20,436 ($1,703 × 12)
- Annual cash flow: $20,400 − $20,436 = -$36/year (breakeven)
Example: -$36 ÷ $64,000 × 100 = -0.06%
This deal barely breaks even on cash flow — but that's common in appreciating markets at current interest rates. Cash-on-cash below 6–8% often means you're betting on appreciation rather than income. Know which game you're playing.
7. Gross Rent Multiplier (GRM)
Formula: Purchase Price ÷ Annual Gross Rent
Example: $320,000 ÷ $28,800 = 11.1
GRM is an inverse of gross yield — lower is better. It tells you how many years of gross rent it would take to pay back the purchase price. Used primarily as a quick screening tool to compare similar properties. GRM under 10 is generally considered favorable for income-focused investing.
8. Debt Service Coverage Ratio (DSCR)
Formula: NOI ÷ Annual Debt Service (total mortgage payments)
Example: $20,400 ÷ $20,436 = 0.998
DSCR measures whether the property generates enough income to cover its debt payments. Lenders typically require a minimum DSCR of 1.20–1.25 for investment property loans. A DSCR below 1.0 means the property doesn't cover its own debt — you're subsidizing it from other income.
This property's DSCR of 1.0 (essentially breakeven) is a yellow flag. It works if you have reserve capital and believe in appreciation. It's problematic if you're counting on cash flow.
9. Break-Even Occupancy Rate
Formula: (Operating Expenses + Debt Service) ÷ Gross Potential Rent × 100
Example: ($8,400 + $20,436) ÷ $28,800 × 100 = 100.1%
This tells you what occupancy rate you need just to break even on all costs. A break-even occupancy of 100% means there's zero margin for vacancy. This is a warning sign — any vacancy at all creates a loss.
In strong rental markets, break-even occupancy of 85–90% is acceptable. Above 95% means the deal has essentially no cushion.
10. Internal Rate of Return (IRR)
Formula: The discount rate that makes Net Present Value of all cash flows equal zero. Requires a multi-year projection.
IRR is the most comprehensive return metric because it accounts for:
- Annual cash flows (positive or negative)
- Principal paydown on the mortgage
- Projected appreciation
- Net proceeds from eventual sale
- Time value of money
Approximate example (10-year hold, 4% annual appreciation):
- Year 10 sale price: ~$473,000
- Remaining loan balance: ~$214,000
- Net sale proceeds after costs (~8%): ~$397,000 − $214,000 = $183,000
- Plus 10 years of modest cash flows and equity buildup
- Estimated IRR: 12–14%
This reveals why many investors tolerate breakeven cash flow in appreciating markets — the 10-year IRR can be compelling even when monthly cash flow is minimal.
How to Use These Metrics Together
No single metric tells the whole story. Here's how to read them in concert:
- Screen with: 1% rule, GRM, gross yield — fast filters to eliminate obvious non-starters
- Underwrite with: NOI, cap rate, cash-on-cash, DSCR — the core investment metrics
- Stress-test with: Break-even occupancy — what's my margin of safety?
- Project with: IRR — what's the 10-year picture if my assumptions hold?
The investors who consistently build wealth in real estate aren't luckier — they're more disciplined. They calculate these metrics on every deal, understand what they're measuring, and only buy when the numbers make sense for their strategy.
The deal above may not be a home run in Year 1. But with 4% annual appreciation, good tenants, and a 10-year hold, it likely generates a 12–15% IRR — better than the S&P 500 long-term average on a tax-advantaged, leveraged basis. That's why people buy rentals even when cash flow is thin.
Know your numbers. Know your strategy. Buy accordingly.