Why cap rate alone is misleading
Cap rate ignores financing — two identical properties with different loans have wildly different cash returns. Always look at cap rate, cash-on-cash, and DSCR together. A 5% cap deal with 25% down and a 7% loan can still cash-flow if rents are conservative and operating expenses are tight.
- • Cap rate is the bond-equivalent yield of the asset, not the investor's return.
- • Cash-on-cash compares your actual capital to your actual cashflow.
- • DSCR tells you if the property pays its own mortgage with a margin of safety.
The 50% rule (and why it's a starting point, not gospel)
A common back-of-envelope: assume 50% of gross rent goes to non-mortgage expenses (taxes, insurance, vacancy, repairs, capex, management). It overstates expenses in newer suburban homes and understates them in older urban properties. Our 35% default is closer to a well-maintained SFR — push to 45–50% for older buildings, multi-unit, or self-managed Section 8.
Don't skip capex reserve
Roof, HVAC, water heater, paint, flooring — pretend that bill arrives on Jan 1, 2030 and you need to be ready. Setting aside $150–$300/door/month for capex is the difference between a real rental business and a 5-year fairy tale.
FAQ
What's a good cap rate for residential?
Stabilized residential cap rates run 4–6% in coastal cities and 7–10% in cashflow Midwest markets. Anything above 10% deserves extra scrutiny — usually means deferred maintenance, weak tenants, or a tough neighborhood.
What DSCR do lenders require?
Most DSCR / non-QM lenders require 1.20–1.25 minimum. Below 1.0 means the property doesn't cover its own debt service — you'd be feeding it cash each month.
How is this different from a mortgage calculator?
Mortgage calculators tell you the monthly P&I. This tells you whether the deal makes sense after all expenses, vacancy, and capex.
Does it work outside the US?
Yes — drop in your local price, rent, and interest rate. UK BTL, Canadian, Australian, and EU buy-to-rent all use the same NOI / cap rate framework.
Where do I get reliable rent comps?
Zillow Rent Zestimate, Rentometer, and recent listings on Zillow/Realtor.com are starting points. The single best data source is a local property manager — they'll tell you the actual rent in 5 minutes.