Question 1

How is rental property cash flow calculated?

Accepted Answer

Annual cash flow = NOI − Annual Debt Service − CapEx Reserves. NOI = Gross Potential Rent − Vacancy/Credit Loss − Operating Expenses. Annual debt service = monthly P&I × 12. CapEx reserves are the line most investors omit — typically 5–10% of effective rent for residential, set aside annually to fund roof / HVAC / appliances replacements that occur on 10–25 year cycles.

Question 2

What's the difference between cash flow, cash-on-cash, and ROI?

Accepted Answer

Cash flow is dollars per year (or month). Cash-on-cash return is a percentage: annual pre-tax cash flow / total cash invested (down payment + closing costs + initial rehab). ROI typically refers to total return including appreciation + principal paydown + tax benefits — broader than cash-on-cash. Use cash-on-cash for current-year economics; use IRR for full-cycle return that includes appreciation and refinance / sale proceeds.

Question 3

What vacancy assumption should I use?

Accepted Answer

Pull the actual figure from your local market — RentCafé, CoStar, Zillow rentals, and your county's Census ACS data all publish vacancy rates by submarket. Don't use the listing pro-forma's 3% if the submarket runs 7–8%. Operator-grade default for stabilized class-B/C residential: 7–8%. Class-A multifamily in strong markets: 4–6%. Less-stable markets or highly turnover-prone properties: 10–12%. Always sanity-check against actual T-12 vacancy from the seller.

Question 4

What operating expenses should I include?

Accepted Answer

Property taxes (use the post-sale re-assessed amount, not the seller's grandfathered bill), insurance (get a current quote — premiums in coastal and wildfire-exposed states have spiked since 2022), property management (8–10% of effective rent even if self-managing — your time has a cost), repairs & maintenance (5–10% of effective rent for stabilized), utilities the landlord pays, HOA fees, marketing/leasing (1 month rent per unit per turn), accounting/legal, and any pass-through utilities not back-billed to tenants.

Question 5

Why does CapEx matter and how do I estimate it?

Accepted Answer

Capital expenditures are roof replacement, HVAC system, water heater, exterior paint, paving, major plumbing — items that last 10–25 years and are NOT included in NOI. A property with 'great cash flow' that needs a $20K roof in two years has very different actual returns than a freshly-renovated comp. Operator-grade approach: build a CapEx reserve schedule by component (roof: $X / Y years remaining = $X/Y annual reserve; HVAC same; water heater same), sum the annuals, deduct from cash flow. Common shortcut: 5–10% of effective rent for residential. The shortcut overstates returns on older deferred-maintenance properties.

Question 6

How do Fannie Mae's residential investment-property rules affect underwriting?

Accepted Answer

If you're financing 1–4 unit residential investment property with conforming Fannie Mae / Freddie Mac financing, key rules: minimum 15–25% down (varies by property type and number owned), 6 months reserves required for each financed property beyond the primary, 75% of rental income credited toward DTI (the 25% haircut covers vacancy and management), debt-coverage ratio must support both PITIA + total household debt. Above 4 units shifts to commercial loans (different qualifying, different rates, often non-recourse for larger deals). DSCR loans on small residential are an alternative — they qualify the property, not the borrower.

Question 7

What's a 'good' cash-on-cash return?

Accepted Answer

Operator-grade range as of 2026: 6–10% cash-on-cash on stabilized residential rental in most U.S. markets is reasonable. Below 5% requires meaningful rent growth or appreciation thesis to be defensible. Above 12% in low-risk markets usually means an assumption is wrong (under-stated vacancy, under-stated CapEx, ignored taxes-at-reassessment) or there's a material reason the property is mispriced (deferred maintenance, problem tenants, regulatory exposure). Always interrogate outliers in both directions.

Question 8

How does depreciation factor into cash-on-cash?

Accepted Answer

Cash-on-cash is pre-tax. Depreciation is a non-cash expense that reduces TAXABLE income but not actual cash flow — so it doesn't appear in cash-on-cash directly. Where it matters: the after-tax cash-on-cash return, which can be meaningfully higher than pre-tax for high-bracket investors because depreciation shelters operating income (IRC §168 — 27.5-year straight-line for residential, 39 years for commercial). The §469 passive-activity rules limit how much depreciation can offset non-passive income for non-real-estate-professionals, but unused losses carry forward and offset eventual sale gain.

Yr	NOI	Cash flow	Property value	Loan balance	Equity
1	$33,400	$671	$500,000	$371,191	$128,809
2	$34,402	$1,590	$515,000	$367,106	$147,894
3	$35,434	$2,536	$530,450	$362,726	$167,724
4	$36,497	$3,510	$546,364	$358,030	$188,334
5	$37,592	$4,513	$562,754	$352,993	$209,761

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