Rental Property Numbers: Cap Rate, Cash Flow and the 1% Rule
The 1% rule takes ten seconds and tells you whether to spend an hour. It is a filter, not an answer, and treating it as an answer is how people buy bad deals.
By Rohit Sharma, Founder, SEOShouts
Property investment has a vocabulary of metrics that each answer one narrow question. Used together they describe a deal well. Used alone, each one hides something important.
Net operating income
Everything starts here. NOI is rental income minus operating expenses, before any financing.
NOI = gross rent − vacancy − operating expenses
Operating expenses exclude mortgage payments. That exclusion is deliberate, so the property can be judged separately from how it was financed.
A property renting at £1,500 a month is £18,000 a year gross. Allow 8 per cent vacancy, £1,440, and £6,000 of operating costs, and NOI is £10,560.
Capitalisation rate
cap rate = NOI ÷ purchase price
Expressed as a percentage. It is the unleveraged annual return, and it lets properties of different prices be compared directly.
On a £200,000 purchase, an NOI of £10,560 is a 5.3 per cent cap rate. Because financing is excluded, cap rate compares the asset rather than the buyer. What counts as good is entirely local: 4 per cent may be strong in a prime city, while 8 per cent in a declining town may be compensation for real risk.
Cash flow and cash-on-cash return
Cash flow is what reaches your account after the mortgage. It is the number that determines whether you can hold the property through a bad year.
| Line | Annual |
|---|---|
| Gross rent | £18,000 |
| Less vacancy at 8% | −£1,440 |
| Less operating expenses | −£6,000 |
| Net operating income | £10,560 |
| Less mortgage payments | −£8,600 |
| Cash flow | £1,960 |
Cash-on-cash return divides that cash flow by the cash actually invested. With a £50,000 deposit plus £5,000 of costs, £1,960 ÷ £55,000 is 3.6 per cent. That is the return on your money, as opposed to the return on the asset.
The rules of thumb
These exist to triage listings quickly, not to evaluate them.
- The 1% rule: monthly rent should be at least 1 per cent of purchase price. A £200,000 property should rent for £2,000. In most expensive markets almost nothing passes, which tells you the rule was built for different conditions.
- The 50% rule: operating expenses will consume about half of gross rent over the long run. Pessimistic in a new build, optimistic in an older property with deferred maintenance.
- The 70% rule: for flips, pay no more than 70 per cent of after-repair value minus repair costs.
Where the returns actually come from
Cash flow is only one of four. A leveraged rental typically earns through cash flow, principal paydown by the tenant, appreciation, and tax treatment of depreciation. A property with thin cash flow can still perform well if the tenant is steadily buying it for you.
The risk is that appreciation is the component people lean on hardest and the only one they cannot control. A deal that requires prices to rise in order to work is a bet on the market, not an investment in a property.
Frequently asked questions
What is a good cap rate?
It depends entirely on the market. Four to five per cent can be strong in a prime city with reliable demand, while eight per cent in a weak market may simply be pricing in risk of vacancy and falling values.
Does the 1% rule still work?
As a screening filter in affordable markets, yes. In expensive cities almost no property meets it, so applying it strictly would rule out entire regions. Treat it as a way to prioritise which listings deserve a full analysis.
What is the difference between cap rate and cash-on-cash return?
Cap rate ignores financing and measures the return on the asset. Cash-on-cash return divides actual cash flow by the cash you invested, so it measures the return on your money and changes with the mortgage.
Calculators from this guide
About the author
Rohit Sharma is the founder of SEOShouts, a search consultancy in India, and has worked in technical SEO and content strategy since 2014. He builds and maintains Calcshark.