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Cash flow is −$924, but $3,454 of principal paydown and $12,750 of appreciation bring the first-year gain to $15,280 on $97,000 of cash.

Where the first-year gain comes from

year one

NOI$26,220

Debt service−$27,144

Principal paydown$3,454

Appreciation$12,750

Total gain$15,280

The math, with your numbers

Cash invested$97,000Price × down payment + closing and rehab$425,000 × 20% + $12,000

Cash flow−$924NOI − annual debt service$26,220 − $27,144

Principal paydown$3,454Year one of $340,000 at 7% over 30 years

Appreciation$12,750Price × appreciation rate$425,000 × 3%

First-year ROI15.8%(Cash flow + paydown + appreciation) ÷ cash invested(−$924 + $3,454 + $12,750) ÷ $97,000

ROI with no appreciation2.6%(Cash flow + paydown) ÷ cash invested(−$924 + $3,454) ÷ $97,000The part that does not depend on a forecast.

The tax effect of depreciation is left out. It depends on your bracket and basis, and it is recaptured at sale. That is CPA territory.

How this calculator works

Return on Investment = Total Gain ÷ Total Cash Invested. On a rental, total gain has four parts, and cash-on-cash return sees only the first: cash flow, principal paydown, appreciation, and the tax effect of depreciation. Cash flow alone on the $425,000 duplex at 80% leverage and 7% is negative $924 a year. Add the first year of principal paydown, about $3,454 on a $340,000 loan, and a negative cash position becomes a positive $2,530 of equity gain before any appreciation at all.

The four components answer different questions and arrive on different schedules. Cash flow is spendable now. Principal paydown is real but locked in the building until sale or refinance. Appreciation is unrealized and uncontracted. The depreciation deduction lowers taxes now and gets recaptured at sale. Summing them into a single ROI figure means something only when the holding period is stated, because three of the four compound over time.

Key insights

An ROI figure without a time period is not comparable to anything. A 40% return over eight years and a 40% return over two are different investments, which is the gap IRR exists to close.

Principal paydown accelerates over the life of the loan. On this $340,000 mortgage, year one retires about $3,454 and year ten retires about $6,470, because the interest share of a fixed payment shrinks as the balance falls.

Appreciation is where an ROI calculation goes fictional. It is the only one of the four components with no contractual basis, and a 3% assumption on a $425,000 property adds $12,750 in year one, roughly five times the deal’s actual equity gain. Small changes to that one input dominate the output.

Depreciation is less optional than it looks. The recapture rules tax you at sale as though you had claimed it, so skipping the deduction gives up the benefit and leaves the bill. That is CPA territory, and worth raising before the first return rather than after.

Frequently asked questions

What is a good ROI on a rental property?›

The question needs a holding period and a definition before it has an answer, because ROI here bundles cash flow, principal paydown, appreciation, and tax effects. Two deals quoting the same percentage can be built from completely different components, and the components behave differently.

How is ROI different from cash-on-cash return?›

Cash-on-cash counts only spendable cash in one year. ROI adds principal paydown, appreciation, and tax effects. On this duplex, cash-on-cash is negative 1.0% while first-year ROI is positive once paydown is included, and both describe the same property.

Should appreciation be included in ROI?›

Including it is standard and also where most of the error enters, since it is an assumption rather than a contract. Running the calculation with appreciation set to zero shows what the deal returns on income and paydown alone, which is the part that does not depend on a forecast.

How does ROI account for the mortgage?›

Twice, in opposite directions. Debt service reduces cash flow, and principal paydown adds to equity. On this duplex the loan costs $27,144 a year and returns $3,454 of that as equity in year one.

What does rental ROI leave out?›

Time, unless you state the period. It also treats unrealized appreciation and spendable cash as equivalent, and they are not: one pays this month bills and the other requires a sale or refinance to touch.

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