How do you know if a rental property is a good investment?
Work four checks in order: does the rent cover the full expense stack including vacancy, management, maintenance and capex; is the cap rate competitive for that submarket; does cash-on-cash beat what the same money does elsewhere; and does the deal still hold if rent comes in 10% below your estimate.
The steps in short
- Build the expense stack first. Vacancy, management, maintenance, capex reserve, taxes at the basis you'll actually pay, and a real insurance quote. Do this before you look at any return figure, because the return is whatever survives it.
- Compare the cap rate to the submarket. A 6% cap is strong in one ZIP and weak three miles away. Compare against what similar properties in the same submarket trade at, not against a national rule of thumb.
- Check cash-on-cash against your alternative. The question isn't whether the return is positive. It's whether this beats what the same cash does in your next best option, after the work a property demands.
- Stress the rent down 10%. Rerun the whole stack at 90% of your rent estimate. A deal that only works at the top of your comp range is a bet on the estimate.
- Price what you can't undo. Flood designation, foundation, a roof at end of life, and the tax basis you'll be assessed at. These are what turn a marginal deal into a loss after closing.
Most answers to this question hand you a rule. The 1% rule, the 50% rule, a cap rate floor.
Here’s what happens when you actually run one.
Work an example that passes the rule
A house at $280,000 renting for $2,800 a month. That’s exactly 1% of purchase price, the number the rule exists to find.
| Line | Basis | Annual |
|---|---|---|
| Gross rent | $2,800 × 12 | $33,600 |
| Vacancy | 6% of gross | −$2,016 |
| Effective gross income | $31,584 | |
| Management | 8% of collected rent | −$2,527 |
| Maintenance | 8% of collected rent | −$2,527 |
| Capex reserve | 5% of collected rent | −$1,579 |
| Property tax | 1.7% effective rate | −$4,780 |
| Insurance | quoted | −$2,340 |
| Net operating income | $17,831 |
Cap rate is $17,831 ÷ $280,000, or 6.4%. Respectable, and about what a property at the 1% rule produces once the stack is honest.
Now finance it. Twenty-five percent down is $70,000, closing costs around $8,400, so $78,400 of cash goes in. The $210,000 balance at 7% over thirty years costs $1,397 a month.
Net operating income is $1,486 a month. After the mortgage, $89 of it survives — $1,066 a year, on $78,400 of cash. Cash-on-cash is 1.4%.
That’s a property which passes the 1% rule, has no obvious problem, and returns less than a savings account on the cash you tied up in it.
The four checks, against that example
Does the rent cover the full stack? Not the mortgage. The stack. Vacancy, management, maintenance and capex are real costs whether or not you write a cheque for them this year, and an analysis that omits them is describing a different property. Those four lines took $8,649 out of the example above. Leave them out and the same house shows a 9.5% cap rate and 12.4% cash-on-cash, which is how a spreadsheet talks you into a deal.
Is the cap rate competitive for that submarket? Cap rates price risk. A 9% cap two ZIPs over is not a better deal, it’s a different deal, and the premium compensates for something: slower leasing, older stock, a tenant base with thinner reserves.
Does cash-on-cash beat the alternative? This is the check the example fails. Compare against whatever the same $78,400 does in your next best use, adjusted for the fact that this option comes with a roof and a tenant. Aim for 8% to 12%. The gap between that and 1.4% is the whole argument.
Does it survive a 10% rent miss? Rerun at $2,520 a month. Net operating income falls to $15,336 and the deal goes to negative $119 a month. A property that flips from positive to negative because a rent estimate was slightly optimistic was never really positive.
What actually decides it
Three inputs move the answer more than anything else, and all three are knowable before you close.
The tax basis. The example above assumes a 1.7% effective rate, which is above the national middle. Drop it to 1.1% and the same house produces a 7.0% cap, $230 a month and 3.5% cash-on-cash. That single line moves the verdict, so get the county’s actual millage rather than the seller’s current bill. In about 15 states a sale also resets the assessment or strips a cap the seller had built up; most others reassess on a cycle regardless.
The insurance quote. Get a quote with the deductible structure written down. Percentage wind deductibles apply to your dwelling coverage limit, the cost to rebuild the structure, rather than to what you paid. On a house carrying $220,000 of dwelling coverage a 2% wind deductible is $4,400 out of pocket before the policy pays anything, which changes what reserve is adequate.
Where in the comp range your rent sits. If your figure is the highest of six comps, you haven’t estimated the rent, you’ve estimated the best case. Model the median and treat anything above it as upside.
When is the answer yes?
When the deal clears on numbers you can defend, at a rent in the middle of the range, with expenses priced at the basis you’ll actually be assessed at, and it still beats your alternative.
That’s a narrower set of properties than most listings suggest, which is the honest finding rather than a discouraging one. The example above isn’t a bad house. It’s a fairly priced house in a normal market at 7% money, and it doesn’t produce the return the rule implied.
The rules were calibrated when money was cheaper. The arithmetic was not.
The check you can’t run on one house
Everything above concerns a house you already chose. But the finding just above — that the set clearing all four checks is narrower than the listings suggest — is really a claim about the denominator, and it carries an uncomfortable consequence. The fewer properties that clear, the more you have to test to find one.
Most people settle that by working through three or four and buying the best of them. That answers “which of these four”, not “is this one good”.
The alternative is to run the cheapest check first and at scale: does the return clear the bar you need, across everything currently listed, with the full four-check version spent only on what survives. CapScout, which we make, filters listings on a minimum cap rate or rent-to-price ratio and underwrites what clears; PropStream and Mashvisor narrow the field on other signals.
None of them settles the three inputs above. The county’s actual millage, a written insurance quote with its deductible structure, and where your rent sits in the comp range are still yours to verify on the house you actually buy.
General information, not investment, tax or legal advice. Rates, assessment practice and insurance pricing vary; confirm figures for your own market and lender. Investment-property rates typically run above the headline owner-occupied rate used here.
Frequently asked questions
Is the 1% rule still useful?
As a five-second screen, yes. As a buy signal, no. At 7% money a property at exactly 1% lands in the 5% to 7% cap range and low single-digit cash-on-cash once the full stack is priced, depending heavily on the local tax rate. Use it to reject, not to decide.
What counts as a good cap rate?
There's no universal number, because a cap rate prices risk as much as return. Compare against similar properties in the same submarket. A cap rate well above its neighbours is being paid for something, and finding out what is the work.
Should I use gross yield or net?
Gross yield is for sorting a list. Every buying decision needs net, because the gap between them is the entire operating reality of the property. A 12% gross yield and a 4% cap rate frequently describe the same house.
What goes wrong after closing that you couldn't see beforehand?
A carrier non-renewing after a bad hail season, and a tenant base thinning out when a local employer sheds shifts. Neither shows up in an underwrite. Both are arguments for a reserve sized to the market rather than to a rule of thumb.
Stop running these numbers by hand. CapScout computes the cap rate on every listing that clears your floor, and a full ScoutSense underwrite on the ones you pick.
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