Buying a first rental property

Cash flow after honest reserves

Gross rent of $2,400 a month is $28,800 a year. Subtract 6% vacancy ($1,728), 10% maintenance and capital reserve ($2,880) and 8% management on collected rent (about $2,166), and effective income falls to roughly $22,026. Take off tax and insurance of $5,900 and net operating income is about $16,126.

Debt service on $213,750 at 7.25% over 30 years is about $1,458 a month, or $17,496 a year. The property therefore runs roughly $1,370 a year negative on a fully reserved basis — a result that looks like $942 a month positive if you ignore reserves entirely.

Cap rate versus the financing

NOI of $16,126 on a $285,000 price is a 5.7% cap rate. With debt costing 7.25%, leverage works against you: every borrowed dollar earns 5.7% and costs 7.25%. That negative leverage is precisely why cash flow is thin despite a reasonable rent-to-price ratio.

This does not make the deal wrong, but it does define the thesis. You are buying principal paydown, potential appreciation and a future refinance — not current income. Say that explicitly rather than discovering it in year two.

Where the return actually comes from

In year one, roughly $2,150 of the debt service is principal repayment — a real return that never appears in cash flow. Add 2.5% annual rent growth and modest appreciation, and a five-year hold with a sale at $322,000 produces a levered IRR in the region of 9%–11% after 7% selling costs.

Almost all of that comes from the exit and from amortisation. Change the appreciation assumption and the IRR moves violently, which is the honest headline: this is an appreciation bet with an income floor, and it should be sized accordingly.

• • Principal paydown: real return, invisible in cash flow
• • Rent growth: compounds slowly, protects against cost inflation
• • Appreciation: dominant and least controllable driver of IRR
• • Tax depreciation: shelters income, recaptured at sale

Stress the deal before you sign it

Model two months of vacancy in the same year as a $6,000 repair. If that combination forces a distressed sale, the deal is too tight regardless of the projected return. Reserve capital separately from the down payment and treat it as part of the acquisition cost.

Run it yourself

Each link opens the calculator pre-filled with this scenario's numbers.

• Rental ROI calculator
• Mortgage calculator
• NPV of buying a house

Common questions

Is negative cash flow ever acceptable?

Only when it is small, funded from reserves rather than income, and part of a stated thesis such as principal paydown or a near-term rent reset. Negative cash flow you did not plan for is a liquidity problem, not a strategy.

How much should I reserve for capital expenditure?

For an older single-family home, 8%–12% of gross rent is a defensible planning figure. Roofs, HVAC systems and water heaters are certainties on a long enough timeline.

Other scenarios

• First-time buyer putting 5% down
• Pay the mortgage off early or invest the difference
• Refinancing after rates fall

Unfamiliar with a term used here? See the mortgage glossary.