"How to underwrite a rental property, line by line"

The example property

One illustrative property runs through the whole post. It is a single-family house, asking price $160,000, that will rent for $1,750 a month. You put 25% down ($40,000), borrow $120,000 on a 30-year loan, and say the rate you are quoted is around 6.5%. Closing costs come to $4,500, and the house needs $3,500 of work before a tenant moves in.

Every number here is made up to teach the method. Your market will produce different ones. The sequence of lines is what carries over.

Line 1: Gross scheduled rent

This is the top line: the full year of rent if the property stays occupied every single day. For the example house, that is $1,750 a month, so $21,000 a year.

One warning. Use a rent number you can defend with current rental comps, not the rent the seller claims and not a hopeful round figure. Rent is the largest input in the whole analysis. If it is off by $150 a month, every number below it is off too.

Line 2: Vacancy

No rental stays occupied forever. Tenants move out, and the unit sits empty while you clean it, make repairs, and find the next one. Vacancy is the slice of the year you should expect to collect nothing.

A common planning figure is 5% to 8%, depending on the area and the property. Use 5% here. That is $1,050 a year removed from the top line.

Gross rent of $21,000 minus $1,050 of vacancy leaves $19,950. That figure, the rent you can actually count on collecting, is what the rest of the math runs on.

Line 3: Property taxes

Taxes are usually the largest operating expense. Look up the actual annual amount from the county record rather than guessing. For the example property, taxes are $2,300 a year.

One thing to check: in many areas the assessed value resets after a sale, so the next owner's tax bill can be higher than the current one. Worth a phone call to the assessor before you commit.

Line 4: Insurance

A landlord insurance policy costs more than a standard homeowner policy. Get a real quote for the specific address instead of using a rule of thumb, because the figure swings with location and the age of the house.

For the example property, insurance is $1,250 a year.

Line 5: Property management

A property manager typically charges around 8% to 10% of collected rent, plus fees when a unit turns over. At 10% of $21,000, that is $2,100 a year.

Count this line even if you plan to manage the property yourself. Your time has a value, and you may not always want the job. A deal that only works because you are doing unpaid labor is a thinner deal than it looks.

Line 6: Maintenance and repairs

This is the ongoing small stuff: a leaking faucet, a broken garbage disposal, a fence repair, a service call when the heat quits. It is not the same as the big replacements in the next line.

A reasonable planning figure is 5% to 10% of rent, higher for an older house. Use 8% here, which is $1,680 a year. Some years you will spend less. One bad year will spend it all.

Line 7: CapEx reserves

CapEx, short for capital expenditures, covers the expensive, occasional replacements: the roof, the HVAC system, the water heater, flooring, the kitchen. These do not come up every year, but when they do they cost thousands at once.

The way to handle them is to set money aside every month so the cash is there when the roof fails. Budget another 8% of rent, another $1,680 a year, into a reserve.

This is the line beginners skip most often, because nothing breaks in year one and the reserve feels like wasted money. Then year six arrives with a $9,000 roof, and the investor who never reserved has to cover it out of pocket or borrow.

Adding up operating expenses

Operating expenses are every cost of running the property except the mortgage. For the example property:

• Property taxes: $2,300
• Insurance: $1,250
• Property management: $2,100
• Maintenance and repairs: $1,680
• CapEx reserves: $1,680

Total operating expenses: $9,010 a year.

Net operating income (NOI)

NOI is the rent you can count on collecting, minus operating expenses. It deliberately leaves the mortgage out, because NOI measures the property itself, separate from how you financed it.

NOI = collected rent − operating expenses

For the example property: $19,950 − $9,010 = $10,940 a year.

Line 8: Debt service

Debt service is the mortgage payment: principal and interest. On a $120,000 loan over 30 years at an example rate of 6.5%, the payment is about $759 a month, which is $9,102 a year.

It sits below NOI because it belongs to your loan, not to the property. A cash buyer would have the same NOI of $10,940 and no debt service at all.

Cash flow

Cash flow is what lands in your account after everything is paid, the mortgage included.

Cash flow = NOI − debt service

For the example property: $10,940 − $9,102 = $1,838 a year, which is about $153 a month.

That is the honest bottom line. Compare it to the $696 a month the four-line beginner math promised at the top of this post. Same property, same rent, same price. The difference is vacancy, management, maintenance, and CapEx. Those four lines cost the deal roughly $543 a month, and an investor who never wrote them down would not see it coming.

The return metrics

Cash flow tells you the dollars. Two ratios tell you whether those dollars are a good use of your money.

Cap rate is NOI divided by the purchase price. It is the return the property would earn if you paid all cash, so it ignores financing and lets you compare properties on equal footing.

Cap rate = NOI ÷ price

For the example property: $10,940 ÷ $160,000 = 6.8%.

Cash-on-cash return measures annual cash flow against the actual cash you put into the deal. Here that cash is the $40,000 down payment plus $4,500 in closing costs plus $3,500 in upfront repairs, so $48,000 total.

Cash-on-cash = annual cash flow ÷ cash invested

For the example property: $1,838 ÷ $48,000 = 3.8%.

Whether 3.8% and $153 a month is good enough is your call. It depends on your goals, what else you could do with $48,000, and how much you expect the property and the rent to grow over time. Underwriting gives you honest numbers to make that decision with.

The checklist

When you underwrite a rental, run the lines in this order every time:

1. Gross scheduled rent
2. Vacancy
3. Property taxes
4. Insurance
5. Property management
6. Maintenance and repairs
7. CapEx reserves
8. Debt service

That gets you to NOI, then cash flow, then cap rate and cash-on-cash. Eight lines. Most failed beginner deals are failures of lines 2, 5, 6, and 7, the ones with no monthly bill attached, so they are easy to forget and easy to set too low.

Real estate investing carries risk, including the risk of losing money, and no analysis removes that. Underwriting only makes the risk visible before you buy instead of after. The numbers above are illustrative, every market is different, and you should do your own diligence and talk to qualified professionals before committing to a deal.

Building this full pro forma takes real time, which is why doing it on every listing is not realistic. Whoof does the first-pass version of this math for you, so you only sit down and build the complete eight-line analysis on the properties that already look worth the time.