If you've started looking at rental properties, you've probably run into a wall of abbreviations. Cap rate. NOI. ARV. Cash-on-cash. They get thrown around like everyone already knows them, and nobody stops to explain.
Here's the good news: there are only about a dozen terms you really need to evaluate a deal, and none of them are complicated once someone walks you through them. This post does that. For each term you'll get a plain definition, how investors actually use it, and why it matters.
To keep things concrete, we'll use one example property the whole way through: a single-family home priced at $200,000 that rents for $2,000 a month. It's a simplified illustration, so treat the math as a teaching tool. Your real numbers will look different.
Part 1: Knowing what a property is worth
Before any other math means anything, you need a grounded estimate of value. These two terms are where evaluation starts.
1. Comps (comparable sales)
Comps are recently sold properties that are similar to the one you're looking at: similar size, similar condition, similar location, sold recently. They're the evidence behind a property's value.
How it's used: You pull 3 to 5 recent sales nearby that match your property as closely as possible, then use their sale prices to estimate what your property is worth. A house that sold last month two streets over for $205,000 tells you a lot more than a listing price someone made up.
Why it matters: A seller's asking price is an opinion. Comps are facts. Almost every other number in this post depends on a value estimate, and comps are how you get one you can trust.
2. ARV (after repair value)
ARV is what a property will be worth after you've fixed it up. It's the price it would sell for once the work is done, which is different from its value in current, unrenovated condition.
How it's used: You estimate ARV using comps too, except you look at sales of renovated homes rather than fixer-uppers. If updated 3-bedroom houses in the area sell for $300,000, that's a reasonable ARV for a similar house you plan to renovate.
Why it matters: ARV decides whether a repair project makes money, especially a house flip. Get it wrong and every decision after it is off. It's an estimate, so be conservative. Hopeful ARVs are how people lose money.
Part 2: Following the money
Once you have a value, the next question is how much money the property actually puts in your pocket. That comes down to income in, expenses out, and what's left.
3. Operating expenses
Operating expenses are the regular costs of running a property: property taxes, insurance, repairs and maintenance, property management fees, and similar ongoing items. One important detail: operating expenses do not include your mortgage payment. That gets counted separately.
How it's used: You add up the yearly cost of every recurring item. For our example property, say taxes, insurance, maintenance, and management come to about $9,000 a year.
Why it matters: New investors almost always underestimate expenses. A property that looks profitable on rent alone can lose money once the real costs show up. Honest expense numbers keep you out of bad deals.
4. Vacancy rate
Vacancy rate is the percentage of time a rental sits empty between tenants. No property stays occupied 100% of the time forever, so smart investors plan for the gaps.
How it's used: You subtract an expected vacancy percentage from your rental income before doing the rest of the math. A common assumption is 5% to 8%. On our property, 5% of $24,000 in annual rent is $1,200, which leaves $22,800 in income you can actually count on.
Why it matters: If you run your numbers as if the property is always rented, every other figure looks better than reality. Building in vacancy keeps your estimate honest.
5. NOI (net operating income)
NOI is the income a property generates in a year after operating expenses, but before the mortgage. It's the property's own performance, separate from how you chose to finance it.
NOI = income (after vacancy) − operating expenses
Example: Our property brings in $22,800 after vacancy. Subtract $9,000 in operating expenses, and the NOI is $13,800 a year.
How it's used: NOI is used directly in the cap rate calculation (coming up next), and it's the cleanest way to compare two properties without your loan terms getting in the way.
Why it matters: Because NOI ignores financing, it shows you how good the property itself is. Two investors can buy the same building with very different loans, but the NOI is the same for both.
6. Cash flow
Cash flow is the money left over each month after everything is paid, including the mortgage. Positive cash flow means the property pays you. Negative cash flow means you pay to keep it.
Cash flow = NOI − mortgage payment (debt service)
Example: Our property's NOI is $13,800. If the mortgage runs about $1,000 a month, that's $12,000 a year. Cash flow is $13,800 − $12,000 = $1,800 a year, or about $150 a month.
How it's used: Many buy-and-hold investors treat cash flow as a go or no-go number. They want it positive, with enough cushion to absorb a surprise repair.
Why it matters: Cash flow is what you live with month to month. A property can grow in value over time, but negative cash flow drains your bank account the whole way there.
Part 3: Measuring the return
Knowing a property makes $1,800 a year is useful. The bigger question is whether $1,800 is a good return for the money and effort you put in. Return metrics answer that.
7. Cap rate (capitalization rate)
Cap rate is the annual return a property would produce if you bought it with cash, no loan involved. It's written as a percentage.
Cap rate = NOI ÷ property price
Example: $13,800 NOI ÷ $200,000 price = 0.069, or a 6.9% cap rate.
How it's used: Cap rate is the quickest way to compare properties and whole markets on equal footing. Investors also talk about a market's typical cap rate, which helps you spot when a property is priced high or low.
Why it matters: A higher cap rate usually means a higher return, and often more risk. A lower cap rate often means a safer, more in-demand area. Neither is automatically better. It depends on what you're after.
8. Cash-on-cash return
Cash-on-cash return measures the annual cash flow against the actual cash you put into the deal: down payment, closing costs, and any upfront repairs.
Cash-on-cash return = annual cash flow ÷ total cash invested
Example: Say you put $50,000 down and spent $5,000 on closing costs, so $55,000 of your own cash is in the deal. With $1,800 of annual cash flow, that's $1,800 ÷ $55,000 = 3.3%.
How it's used: This is the return metric for investors who use a mortgage, because it counts your loan and reflects what your own money is earning.
Why it matters: Cap rate ignores financing. Cash-on-cash includes it. If you're borrowing to buy, cash-on-cash is closer to the return you'll actually feel.
9. ROI (return on investment)
ROI is the broad term for any measure of what you earn compared to what you put in. Cap rate and cash-on-cash return are both specific types of ROI.
How it's used: When someone asks about a property's ROI, they want to know the full picture of return, which can include cash flow, the loan being paid down by tenants, and the property gaining value over time.
Why it matters: "ROI" on its own is a little vague, since it can include or exclude all sorts of things. That's exactly why investors lean on the specific metrics above. When you hear "ROI," it's fair to ask: return on what, and over what time period?
Part 4: Quick screening rules
The metrics above take real numbers and a little time. Sometimes you just want to glance at a listing and decide whether it's worth a closer look. These rules of thumb are built for that. They're rough filters, not final answers.
10. The 1% rule
The 1% rule says a rental's monthly rent should be at least 1% of its purchase price. It's a fast sniff test for whether a property has a shot at cash flow.
Monthly rent ≥ 1% of purchase price
Example: 1% of $200,000 is $2,000. Our property rents for $2,000, so it meets the rule exactly.
How it's used: Investors use it to skim listings quickly and drop the ones that clearly won't work, without running full numbers on every single one.
Why it matters: It's a time-saver, nothing more. Plenty of good deals miss it and plenty of bad deals pass it. A property that clears the 1% rule still needs a real analysis before you'd ever buy it.
11. The 70% rule
The 70% rule is used by house flippers. It says you should pay no more than 70% of a property's ARV, minus the cost of repairs.
Max offer = (ARV × 0.70) − repair costs
Example: If a flip has a $300,000 ARV and needs $50,000 of repairs: ($300,000 × 0.70) − $50,000 = $210,000 − $50,000 = $160,000. That $160,000 is your target purchase price.
How it's used: Flippers use it to set a maximum offer fast. The 30% gap left over is meant to cover holding costs, selling costs, and profit.
Why it matters: It's a starting point, and it depends entirely on an accurate ARV and repair estimate. In competitive markets some investors adjust the percentage. Treat it as a guide for the conversation, not a guarantee.
12. GRM (gross rent multiplier)
GRM compares a property's price to the rent it brings in, before any expenses. It's a quick way to gauge whether a price is reasonable for the income.
GRM = property price ÷ gross annual rent
Example: $200,000 price ÷ $24,000 annual rent = a GRM of 8.3.
How it's used: A lower GRM means you're paying less for each dollar of rent, which is generally better. Investors compare the GRM of several properties in the same area to spot the ones priced well.
Why it matters: GRM is fast because it skips expenses entirely. That's also its weakness. Two properties with the same GRM can perform very differently once taxes and repairs are counted, so it's a screening tool, not a verdict.
Putting it together
You don't need to memorize formulas to be a good investor. You need to understand what each number is telling you.
A couple of things worth keeping in mind. No single metric decides a deal. A property can have a great cap rate and thin cash flow, or pass the 1% rule and still be a poor buy. Investors look at several numbers together and at what each one is built on. And every figure here starts from estimates: comps, ARV, rent, expenses, vacancy. The math is only as good as those inputs, so the real skill is getting honest estimates and staying conservative.
Run the numbers on a few real listings in an area you know. The terms will go from abstract to familiar faster than you'd expect.
This post is for educational purposes only and is not financial or investment advice. Real estate investing involves risk, including the risk of loss. Always do your own research and run your own numbers before making an offer.
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