Every rental makes money in one of two ways: cash flow, the money left over each month, and appreciation, the value going up over time. Both are real. But only one of them pays your bills while you own the property.
Here is a simple way to compare two rentals and see which kind of deal you are really buying.
Two houses, side by side
These are made-up examples to show the math.
- House A: $250,000 price, rents for $2,200 a month
- House B: $450,000 price, rents for $2,700 a month
House B rents for more, so it looks like the better deal. Let’s check.
Step 1: Annual rent
- House A: $2,200 × 12 = $26,400
- House B: $2,700 × 12 = $32,400
Step 2: Subtract operating expenses
Taxes, insurance, repairs, vacancy, and management add up fast. A common rough estimate is 40% of the rent. Your real numbers will be different, so use them when you have them.
- House A: $26,400 − $10,560 = $15,840 net operating income
- House B: $32,400 − $12,960 = $19,440 net operating income
Step 3: Divide by the price
That gives you the cap rate, the return the property earns before any mortgage.
- House A: $15,840 ÷ $250,000 = 6.3%
- House B: $19,440 ÷ $450,000 = 4.3%
House A earns about half again as much on every dollar invested. House B costs $200,000 more and brings in only $3,600 more a year.
What that tells you
House A is a cash-flow deal. It earns its keep every month. House B is mostly an appreciation deal. Once you add a mortgage, it may barely break even or even cost you money each month, and you are counting on the value going up to make it worth it.
That is not automatically bad. Appreciation has made a lot of people wealthy. But it is a bet on the future, and you need the cash to cover the gap while you wait.
My rule of thumb
Buy for cash flow and treat appreciation as a bonus. A property that pays for itself can ride out a bad market. A property that depends on prices going up can force you to sell at the worst time.
Want a second set of eyes on a rental you are looking at? Send me the numbers.
This article is for education only. It is not legal, tax, or financial advice. Laws vary by state, so talk to a licensed attorney, CPA, or financial professional before you act on anything you read here.
