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Short Summary
Main recommendation: Calculate a rental property's cash flow using its real, actual rents (not the seller's projected income), subtract all fixed expenses to get net rental income, then factor in mortgage payments and principal paydown to measure total return. The video walks through this with a $360,000, three-unit building renting at $1,000 per unit, showing a 6.63% cap-rate-style return on a cash purchase and about a 12.6% first-year total return with a 20% down, 5% 30-year mortgage.
Key Points
- Use actual income, not projected income: Projected rent is the seller's optimistic guess of what a unit could rent for at market rates, so Graham ignores it and does his own estimate.
- Gross income: Include rent plus any other income such as laundry, storage, or parking; the example assumes these are zero.
- Net rental income = gross income minus fixed expenses, which exist even with no mortgage (property tax, insurance, HOA, utilities if paid by owner, upkeep, repairs, property management, and vacancy).
- Cash-on-cash return is the annual net rental income (after mortgage) divided by total cash invested (down payment plus closing costs), times 100.
- Total first-year return also counts principal paid down on the loan, which Graham treats as real equity income.
Details Worth Noting
- Concrete instructions:
- Step 1: Calculate gross income by adding all monthly rents (and any other income sources) and multiplying by 12 for the annual figure.
- Step 2: List fixed monthly expenses: property taxes, insurance, HOA, utilities you pay, gardening/upkeep, repairs, property management, and a vacancy allowance. In the example these total $1,010/month: taxes $360, insurance $150, HOA $50, utilities $0, gardener $50, repairs $100, property management $200, vacancy $100.
- Step 3: Net rental income = gross rent minus fixed expenses ($3,000 − $1,010 = $1,990/month, or $23,880/year).
- Cash-only return: net annual income ÷ purchase price × 100 (example: $23,880 ÷ $360,000 = 6.63%).
- Step 4: With a mortgage, use a mortgage calculator (Graham uses mortgagecalculator.org) with a 20% down payment, 5% interest, 30-year term. This gives a $1,546/month payment.
- Monthly cash flow after mortgage: $1,990 − $1,546 = $444/month, or $5,328/year.
- Total cash invested: $72,000 down payment plus about $3,600 closing costs (1% of purchase price) = $75,600.
- Cash-on-cash return: $5,328 ÷ $75,600 × 100 ≈ 7%.
- Step 5: Find year-one principal paydown on the calculator's annual amortization schedule (example: $4,249). Add it to the $5,328 cash return for $9,577 total, then divide by $75,600 and multiply by 100 for about 12.6%.
- Practice: Graham recommends practicing by picking a few listed properties, estimating rent, and repeating the process about ten times, saying this will help you learn it well.
- Graham says he uses the same formula to compare a property's expected return against other listings to judge whether it is overpriced or underpriced.
- He notes that this return model assumes stable rents, and that renovation and rent increases can raise returns further.
- Caveat: The rent, expense, and interest-rate figures are illustrative examples chosen by the speaker, not market data.
Bottom Line
A property's real value to you comes from its net cash flow and principal paydown, calculated from your own rent and expense estimates rather than the seller's numbers.
