Cap rate and cash flow are the two numbers every rental property analysis comes back to, and they measure different things. Cap rate is a property’s net operating income divided by its purchase price, expressed as a percentage — a way to compare properties independent of financing. Cash flow is what’s actually left over each month after every expense is paid, including your mortgage, and it depends heavily on how you financed the deal.
Why Bay Area cap rates run low
Cap rates in Fremont, Milpitas, San Jose, Santa Clara, Union City, and Newark tend to run lower than in many other parts of the country, simply because purchase prices are high relative to achievable rents. That doesn’t necessarily make a deal bad — many Bay Area investors are underwriting for long-term appreciation and equity growth rather than immediate cash flow, which is a different strategy with a different risk profile than a high-cash-flow, lower-appreciation market elsewhere.
Running the numbers
To estimate net operating income, add up expected rental income, then subtract vacancy allowance, property taxes, insurance, maintenance and repairs, and property management if you plan to hire one — before subtracting anything for the mortgage. Some investors use a rough screening tool like the “1% rule” (monthly rent at or above 1% of purchase price) to quickly filter listings, but treat it as a rough filter, not a substitute for running your actual numbers on a specific property.
The IRS Publication 527 on residential rental property covers which expenses are deductible for tax purposes, which affects your after-tax cash flow and is worth reviewing with a tax professional for your specific property.
Where this fits into your strategy
If you’re weighing a stand-alone rental against adding a unit to a home you already own, compare the numbers against ADU Investment Guide and House Hacking, both of which can produce different cash flow profiles than a separate purchase. For financing options that affect your cash flow directly through your interest rate and terms, see Financing Investment Property.
Return to Buying Your First Rental Property in the Bay Area or the main Investing in Bay Area Real Estate guide for the rest of the investing topics.
Considering selling instead of holding?
If you’re weighing a sale against continuing to hold a property, get a free estimate at the Home Value Estimator and see the Seller’s Guide.
This page is general information, not investment or tax advice, and not a guarantee of any specific return. Actual cap rates, expenses, and cash flow vary by property — run your own numbers and consult a tax professional before investing.
Laxmi Penupothula · Intero Real Estate · DRE #02047105 · Serving Fremont, Milpitas, San Jose, Santa Clara, Union City & Newark. Equal Housing Opportunity.