How do you know if a rental property is a good investment?

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.

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.