Most of the vocabulary in rental investing is one of three things in disguise: what the house earns, what the loan takes, or what you got back for the cash you put in. Learning ten words at once is hard. Watching ten words describe one house is not.
So here is one house, and every term measured against it.
It costs $250,000. You put 20% down, which is $50,000, with closing costs at 3% of the price, another $7,500, so $57,500 of your cash goes in. The loan is $200,000 at 7% over thirty years. It rents for $2,750 a month. Property taxes run $3,000 a year and insurance $1,400. The example sets aside 5% of rent for empty months, 5% for maintenance and 5% for big repairs like a roof, and pays a manager 8%.
| This house | What it measures | |
|---|---|---|
| Cash flow | $420 a month | What is left after every cost, the mortgage included |
| Net operating income (NOI) | $21,010 a year | Income after running costs, before the mortgage |
| Cap rate | 8.4% | NOI as a share of the price, with no loan in it |
| Cash-on-cash return | 8.8% | A year of cash flow against the cash you put in |
| Debt service coverage ratio (DSCR) | 1.32 | How many times NOI covers the mortgage |
| Gross rent multiplier (GRM) | 7.6 | Price divided by a year of rent, before any cost |
| The 1% rule | 1.10% | Monthly rent as a share of the price |
| Break-even rent | $2,205 a month | The rent at which cash flow reaches zero |
| Value at a 7% cap rate | $300,142 | What this NOI is worth to a buyer wanting 7% |
| Internal rate of return (IRR) | 17.5% over ten years | One rate covering cash flow, payoff and the sale |
These are example figures, not a forecast for any market.
What do cash flow and NOI mean?
Cash flow is the only number on the list that lands in a bank account. It is the rent minus every cost, the mortgage included.
Net operating income is the same arithmetic stopped one line early, before the mortgage. That sounds like a technicality and it is not: NOI describes the house, and cash flow describes the house plus your loan. Two buyers with different down payments get the same NOI and very different cash flow.
| Each month | |
|---|---|
| Rent | $2,750 |
| Empty months (5% of rent) | −$138 |
| Property taxes | −$250 |
| Insurance | −$117 |
| Maintenance (5% of rent) | −$137 |
| Big repairs (5% of rent) | −$137 |
| Management (8% of rent) | −$220 |
| Mortgage | −$1,331 |
| Cash flow each month | +$420 |
Stop above the mortgage line and you have $1,751 a month, which is $21,010 a year of NOI. Rows are rounded to whole dollars, so one or two land a dollar off the exact figure.
What is a cap rate, and what is cash-on-cash return?
Both are returns. They differ on what they divide by.
Cap rate is NOI divided by the price: $21,010 against $250,000 is 8.4%. There is no loan in it, which is the point. A cap rate lets you compare this house with one bought for cash, and it is the number a buyer uses to put a value on income.
Cash-on-cash return is a year of cash flow divided by the cash you actually spent: $5,043 against $57,500 is 8.8%. The loan is very much in it. Borrow more and your cash flow falls while your cash in falls faster, which is why the two numbers can move in opposite directions on the same house. Cap rate against cash-on-cash return sets them side by side.
The calculator treats 8% cash-on-cash as the mark of a strong rental, and this house clears it.
What is DSCR, and what does a lender do with it?
DSCR is NOI divided by a year of mortgage payments. Here that is $21,010 against $15,967, or 1.32. It answers one question: does the house earn enough to pay its own loan, and by how much.
At 1.00 the rent covers the payment exactly and nothing else. At 1.32 there are 32 cents of income above every dollar of mortgage. Lenders writing loans against the property rather than your paycheck set a floor on it, which is why the ratio shows up in loan terms rather than in listings.
Which of these are filters, not verdicts?
Two of them. Both are fast, both ignore costs, and both are meant to sort a list rather than settle a decision.
The 1% rule asks whether monthly rent is at least 1% of the price. Here $2,750 on $250,000 is 1.10%, so it passes. It compares two numbers and skips taxes, insurance, vacancy and repairs entirely, which is how two houses that both pass can be hundreds of dollars apart each month.
Gross rent multiplier is the price divided by a year of gross rent: $250,000 against $33,000 is 7.6. A lower number is cheaper per dollar of rent. Like the 1% rule it says nothing about what the rent has to pay for.
Use either to decide which listing deserves five minutes. Neither one knows whether the house makes money.
What is break-even rent, and what is IRR?
Break-even rent is the rent at which cash flow hits zero. On this house it sits just over $2,204, so $2,205 is the first whole dollar that clears every cost. The gap between that and the $2,750 it actually rents for is your margin for a bad year. Break-even rent covers how far that cushion should stretch.
The same idea applies to any input, and the calculator names whichever one is closest to breaking the deal. For this house it is not the rent at all. It is the interest rate: the deal stops working above 9.97%, and you entered 7%, so there are 2.97 points of room.
IRR is the one number that accounts for time. Cash flow arrives monthly, the loan balance falls, the house changes value, and a sale ends it. IRR folds all of that into a single annual rate. Over ten years, with 3% a year of appreciation and 7% selling costs, this house returns 17.5%. Run the projection out to thirty years instead and it is 15.5%, because the early years carry the strongest returns.
Value at a cap rate works the other way round. Divide NOI by the return a buyer wants and you get a price: $21,010 at 7% is $300,142. It is how income property gets priced, and it is why raising NOI by $1,000 adds $14,286 of value at that same 7%.
Which number should you look at first?
Cash flow, then the one that breaks it.
Cash flow tells you whether the house pays you. The break-even figure tells you how wrong your assumptions can be before it stops. Everything else on the list is a way of comparing this house with the next one, and comparisons matter less than whether the first one survives a vacancy and a new roof.
Put your own numbers in and watch which term moves most when you change the down payment. How much rental property you can afford starts from the cash side, and how to buy your first rental property walks the whole sequence from offer to tenant.