Defining a “Good” Rate of Return
Putting it all together
A rental property delivers a “good” return when it exceeds the investor’s cost of capital—commonly referred to as the hurdle rate. This includes borrowing costs, the required return on equity, and a premium for risk, time, and operational effort. In addition, the asset should outperform comparable properties in the same market when measured on consistent metrics such as capitalization rate, rental yield, or cash-on-cash return.
Because performance varies materially by geography, asset class, and vacancy expectations, the practical benchmark is to achieve returns above the local market average after adjusting for those variables.
With Market Context
National data provides helpful context, though it should not replace local analysis:
- Across U.S. counties, the average gross rental yield for three-bedroom properties is approximately 7.45% in 2025, with top-performing counties achieving yields in the 10%–18% range.
- Institutional benchmarks further frame expectations. Core multifamily going-in cap rates—defined as day-one net operating income (NOI) divided by purchase price—averaged approximately 4.73% in Q3 2025.
- From an equity perspective, many residential investors target 6%–10% cash-on-cash returns, adjusted for property risk and management intensity.
How to Calculate Rental Property Returns
1. Determine Effective Gross Income
Start with annualized rental income, then deduct vacancy and credit loss. Add any ancillary income streams such as parking, pet rent, or laundry.
Example:
$2,500 monthly rent × 12 = $30,000 gross rent
Less 5% vacancy = $28,500 effective gross income
2. Subtract Operating Expenses
Account for all recurring operating costs: property taxes, insurance, repairs and maintenance, owner-paid utilities, management fees, HOA dues, and capital reserves. If operating history is limited, apply a conservative expense ratio.
Example:
35% expense ratio × $28,500 = $9,975 in operating expenses
3. Calculate NOI and Capitalization Rate
Net operating income equals effective gross income minus operating expenses. The capitalization rate is NOI divided by the purchase price (or current market value).
Example:
NOI = $28,500 − $9,975 = $18,525
Purchase price = $240,000
Cap rate ≈ 7.7%
4. Incorporate Financing to Calculate Cash-on-Cash Return
Subtract annual debt service from NOI to determine pre-tax cash flow. Divide that figure by total cash invested, including down payment, closing costs, and initial capital expenditures.
Example:
20% down payment = $48,000
Loan amount = $192,000 at 6.5% for 30 years
Annual debt service ≈ $14,563
Pre-tax cash flow = $18,525 − $14,563 = $3,962
Cash-on-cash return ≈ 8.3%
Evaluating Returns Relative to the Local Market
While an 8.3% cash-on-cash return exceeds the national average gross yield, local performance is the decisive factor. Comparable properties within the same submarket provide the most relevant benchmark.
If similar assets are achieving materially higher returns—such as 12%—the discrepancy warrants closer examination.
Use True Local Comparables
Analyze three to five recent, comparable properties with similar characteristics: asset type, unit mix, condition, and location. Estimate vacancy and expenses consistently, then calculate net yield or cap rate.
A return is compelling when it exceeds this local range without relying on optimistic assumptions.
Maintain a Micro-Location Focus
Avoid broad citywide averages. School districts, transit access, walkability, and proximity to major arterials can materially impact rent levels and leasing velocity. If comparable inventory is limited, expand the radius modestly and adjust assumptions to reflect location differences.
Validate Vacancy and Seasonality Assumptions
Vacancy assumptions should align with local market data. If a pro forma assumes below-market vacancy, it should be supported by evidence such as current absorption rates, listing timing, or superior unit features.
Seasonality also matters—peak leasing periods can mask pricing risk that becomes evident during slower months.
Commonly Underestimated Expenses
Turnover and Vacancy Costs
Between tenants, owners should anticipate cleaning, cosmetic repairs, flooring touch-ups, and leasing fees. Each vacant day represents lost revenue.
Example:
$2,400 monthly rent ≈ $80 per vacant day
Six additional vacant days ≈ $480 in lost income
Property Tax and Insurance Increases
Acquisitions often trigger tax reassessments, and insurance premiums can rise due to aging systems or regional risk exposure.
Best practices include:
- Modeling taxes based on purchase price, not historical assessments
- Obtaining detailed insurance quotes and projected renewal increases
- Budgeting an annual allowance for cost “drift”
Depreciation and After-Tax Returns
Residential improvements are depreciated over 27.5 years, reducing taxable income and enhancing after-tax cash flow. Upon disposition, depreciation may be recaptured and capital gains realized, though strategies such as 1031 exchanges can defer tax recognition.
Key Levers That Drive Returns
Three controllable factors influence nearly every rental investment:
- Pricing and presentation, which determine achievable rent
- Vacancy management, which maximizes income-producing days
- Expense control, which preserves NOI
Even modest improvements—such as reducing vacancy by one week—can materially impact annual performance.
Protecting a Strong Return
Sustaining a competitive return requires disciplined leasing, professional presentation, and predictable operating costs.
That is precisely where Willowby Property services add value.
Our tenant placement offering includes next-day listings, professional photography, 3D tours, on-demand showings, instant screening, and automated lease execution—designed to reduce vacancy and improve tenant quality.
Our full-service property management platform provides 24/7 operational support, rent coordination, accounting, maintenance oversight, inspections, and renewals.