Real Estate Investing: NOI, Cap Rate, DSCR & Cash-on-Cash Return Analysis
Evaluate rental properties like an institutional underwriter using Net Operating Income (NOI), Capitalization Rate, Debt Service Coverage Ratio (DSCR), and Cash-on-Cash Return.
Underwriting Rental Properties by the Numbers
Real estate builds wealth through four simultaneous engines: monthly cash flow, principal paydown by tenants, long-term appreciation, and depreciation tax shields. However, buying an overpriced property with underestimated operating expenses can turn an asset into a monthly cash drain. Here are the core underwriting formulas every investor must run before making an offer.
1. Net Operating Income (NOI) & The 50% Expense Rule
NOI is the property's annual gross rental income minus all operating expenses—before mortgage debt service and income taxes.
Formula: NOI = Gross Effective Rental Income - (Property Taxes + Insurance + Vacancy [5–8%] + Repairs [5–8%] + CapEx Reserve [5–8%] + Property Management [8–10%])
2. Capitalization Rate (Cap Rate)
Formula: Cap Rate = Annual NOI ÷ Purchase Price × 100
Cap Rate measures the unleveraged yield of the property if you bought it with 100% cash. It allows you to compare properties across markets regardless of how they are financed.
3. Cash-on-Cash (CoC) Return
Formula: Cash-on-Cash Return = Annual Pre-Tax Cash Flow (NOI - Annual Mortgage Payments) ÷ Total Cash Invested (Down Payment + Closing Costs + Initial Rehab) × 100
4. Debt Service Coverage Ratio (DSCR)
Formula: DSCR = Annual NOI ÷ Annual Total Debt Service (P&I)
Commercial and DSCR investment lenders typically require a minimum DSCR of 1.20x to 1.25x, meaning the property generates 20% to 25% more net operating income than required to pay the mortgage.
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