Buying to hold is judged on the month, not on the resale. Three numbers do most of the work: what the house earns, what that is worth against what it cost, and what you earn on the cash you actually put in.
Net operating income
A year's rent, less an allowance for vacancy and repairs, property management, taxes, insurance and any HOA, before any loan payment. The rent on a listing is the seller's estimate; compare the rents of similar places nearby.
On the sample deal below - $1,900 a month of rent, 8% for vacancy and repairs, 8% for management, $1,800 of taxes and $1,300 of insurance a year - it comes to $16,052 a year, about $1,338 a month.
Cap rate
Net operating income over what the house costs you all in, purchase plus renovation. On the sample, $16,052 over $150,000 plus $40,000 is 8.4%. It compares houses as if each were bought with cash, so it leaves any loan out.
With a loan
With 25% down on $150,000 the loan is $112,500. At 7.5% over 30 years, principal and interest come to about $787 a month, leaving about $551 a month of cash flow.
Cash-on-cash return is a year of that cash flow over the cash you put in: the $37,500 down payment plus the $40,000 renovation, $77,500. Here it is 8.5%. A loan raises it when the house earns more on its cost than the loan costs you each year, and lowers it when it earns less.
The refinance
Once the work is done and the house is rented, a lender may make a new loan on its new value, often up to around 70 to 75% of it for a rental. The new loan pays off the first, and what is left comes back to you.
- At 75% of a $260,000 after-repair value, the new loan is $195,000. It pays off the $112,500 and returns $82,500, more than the $77,500 you put in. But the new payment is about $1,363 a month against about $1,338 of income, so the month runs about $26 short.
- At 70%, the new loan is $182,000 and $8,000 stays in the deal. The payment is about $1,273, the month clears about $65, and the cash-on-cash return on what is left in is 9.8%.
Taking every dollar out is not always the better result. The appraisal sets the value, not the listing's estimate; lenders often want you to have owned the house for some months first; and the new loan has closing costs of its own, which the calculator leaves out.
Try it
The calculator below starts on the rental with the sample deal. Turn on a loan or a refinance, and change any figure.
This guide is general education, not legal or financial advice.