The Truth About Rental Property Cash Flow: It Isn't Your Profit!

Whenever I'm on a first call with a new client looking to buy rental properties in the US, the question arrives inside ten minutes. How much cash flow does it make? $200 a month? $300? It's a reasonable thing to ask. I looked at my first US rental properties in exactly the same way, and that ended badly for me.

My model was simple. I'd look at my all-in cost to purchase (including any renovation), the rent, and the costs, including property taxes, insurance, property management, and a 20% reserve fund for vacancies and repairs. If the number at the bottom of my spreadsheet was at least $250, I'd buy it. Over the first few years that worked out fine. I was making money, and I built my reserve fund to about $300,000. Then in 2023 I watched all of it disappear in less than six months, and ended up losing most of my properties. So I have a strong opinion on this subject, earned through hard lessons that cost me real money, and it isn't the one the pro forma wants you to have.

Is rental property cash flow your profit?

No. It's not profit. It's operating income, and the difference is what I wish I'd understood ten years ago when I first started buying rental properties in the US.

I'll concede the obvious first. Cash flow is essential, and it's one of the most important numbers to screen a deal on. If a house can't cover its mortgage, tax, insurance, management and upkeep out of its rent, you shouldn't buy it, and no amount of appreciation talk changes that. Every property I source for a client has to clear that test on honest figures, and I'd never tell you to skip it.

The problem is what happens next. The buyer sees $300 a month at the bottom of the pro forma and reads it as their profit. Is there enough cash flow? Is $250 enough? Would $400 be better? What is my cash on cash return? That's the question they judge the deal on, and it's the question the spreadsheet was built to answer, because the advertised column is where that $300 came from.

The first thing I'll say is that most of the overseas investors I talk to have wildly optimistic expectations about what that cash on cash return should be. Often, they've been sold the fantasy of the cheap duplex they can buy for $100,000 and rent to two Section 8 tenants for $2,000 a month. The seller's spreadsheet says $500 a month in net cash flow after costs. That's a 20% cash on cash return on their 30% down payment. The problem is that it doesn't exist. More often than not, the seller has wildly (possibly on purpose) underestimated the cost of vacancy, turnover, maintenance and capex. Once those real-world costs kick in on a property like that, your 20% cash on cash spreadsheet return turns into a $10,000-plus per year loss in your actual bank account.

Here's what that money actually is. Rent comes in. The mortgage, the property tax, the insurance and the manager get paid. What's left is net operating income after debt service. Its job is to maintain and repair the asset and to build up reserves for the day something goes wrong. It stays inside the property. All of it. Every penny. It is not a return on the money you put in, and it was never designed to be.

Everybody treats it as a return anyway. I did too, for six years, and it cost me almost my entire portfolio, seven years of work, and almost a complete mental breakdown.

What does the pro forma's cash flow number assume?

Your spreadsheet assumes an average year, every year. But ask any seasoned real estate investor who's been in the game a while and they'll tell you straight, there's no such thing as an average year. That's a fantasy. And if you're building your plans for the money on a fantasy, it's not going to end well for you.

Here's the real rental property deal I'll use for the rest of this article to demonstrate my point.

One convention for the whole article. The house I'm using as an example is a $185,000 purchase, bought with a 30% down payment on a DSCR loan, with $1,800 a month in rent. This is pretty typical of the properties I own, and those my clients buy, and after owning as many as I have, I think this is a pretty accurate illustration.

That $618 is what I call free cash flow. Others might say net operating income. Either way, it's the number before anyone has set aside anything for an empty month or a broken furnace.

Now here's the same house on an average investor's pro forma.

The $438 is the number you're shown. The two reserve lines above it are averages. Over ten years, on a hundred houses, vacancy might well run close to 5% of rent. On your one house, in your first year, it runs at either zero or a lot more than that. Nothing in between.

I should also note that your cost of repairs and capex will vary significantly based on the property, the neighborhood, and the tenant pool. A fully renovated home with everything brand new from sewer line to roof, electrics, plumbing, windows, doors, and everything else, will cost you a lot less to maintain than a cheap house that has had a lick of paint and cheap LVP floors.

That kind of home will also attract a better quality of tenant, much more likely to pay and stay, and pay a premium rent for the low maintenance, stress-free living in a virtually brand new house.

That's my second argument against the $100,000 duplex. At $100,000, you can bet your bottom dollar it's not been renovated for low maintenance ownership. It can't have been, because that kind of deep renovation costs upwards of $100,000 at today's prices. If you're buying at $100,000, that money has not been spent. What you're buying isn't an asset, it's a deferred maintenance and capex invoice you haven't opened yet.

And in many cases I see from turnkey sellers, the insurance line is usually wrong before you even get to the reserves. The policy on the pro forma is the cheapest one the seller could find, and the one you actually want costs more. I've priced six real deals this way recently, on the turnkey seller's figures and then on mine, and the gap between the two columns is the story of my markets hub. The seller's tax and insurance figures are both things you can check yourself in an afternoon, before any reserve question comes up.

Why does a 5% vacancy reserve fail in year one?

Because the event can arrive before the reserve does.

Say the tenant leaves at the end of year one. Or worse, stops paying rent in the first year and you need to evict (it happens). It can take three months before you get the property back, and another couple of months to turn the house and find the next tenant, which is not an unusual length of time for a remote owner. The make-ready (turnover) costs what make-readies cost, and it's more than you think. Two real turnovers of mine came to $9,000 and $7,000, before the empty months recently.

Now look at what the pro forma has set aside by then.

Vacancy at 5% has accumulated $1,080.

Maintenance at 5% has accumulated another $1,080.

Together that's $2,160, against a bill of $10,115 to $12,115.

The reserves cover 18% to 21% of it. The vacancy line on its own covers just 9% to 11%.

So a 5% vacancy reserve covers about a tenth of a real first-year turnover. The other nine tenths come from you. And the owner who was reading the $438 as income has usually spent it. In short, your vacancy reserve assumes you won't suffer a vacancy within the first ten years. In my experience, private tenancies that are well-managed last six to eight years. In cheaper houses and rougher neighborhoods, it's more like two or three.

This is the story behind most of the unhappy turnkey buyers who've called me. The house was fine. The tenant paid. Then the tenant left, and the cash flow of the previous year got obliterated (and then some) within a couple of months.

What happened when my $300,000 reserve ran out?

I should be honest here, because I'm about to tell you to do something I didn't do that cost me.

From 2016 to 2022 I built a portfolio that reached 124 houses. They were cheap, about $80,000 all-in, renting at about $1,200, and they were in the wrong neighborhoods, which is a lesson I've written up elsewhere.

I ran a blanket reserve. Fifteen percent of rent, to cover everything: vacancy, maintenance, capital, the lot. Later I raised it to 20%. That reserve built up to about $300,000, which felt like a lot of money, and by any normal standard it was. If a roof needed replacing, no problem, I had the cash. Same if a few tenants vacated.

Then a run of events landed together. Turnovers. Big capital items. Vacancies. Evictions, late rent, and tenant damage to the houses. All these things I learned were very typical for these kinds of cheap houses in those kind of neighborhoods. The bad stuff happens to all landlords, but it happens a lot more often and to a higher degree here.

All $300,000 evaporated. With the reserve gone, I couldn't fund the next turnover, so houses that came back empty stayed empty, and empty houses don't pay mortgages. In the end I couldn't meet my mortgage commitments.

I can tell you one thing I'd like you to take away from this article. Watching your bank account go from $30,000 a month of positive income and a $300,000 balance to losing money every month, in the space of six months, is humbling. Devastating, even.

Here's the part that matters for you. The reserve wasn't the failure. Twenty percent of rent for everything is twice what most pro formas set aside. The failure was that everything above the 20% was being drawn out and lived on. That money was the cash flow. It looked like profit, so I treated it like profit.

Had I retained it, I may well have had enough in the bank to weather the storm. At the very least I'd have had enough to repair the houses to the point where they could be sold for break-even. I didn't, so I couldn't. That one is on me.

Divide the $300,000 by 124 houses and you get about $2,400 a house. Keep that number in mind for the next section, because my floor today is twice that, and it's one of my golden rules.

What is my reserve rule now?

I have no vacancy reserve. I have no maintenance reserve. I have no capital reserve. Not as line items, anyway.

What I do instead is simpler, and it's worked so much better for me.

Every month, each house pays its mortgage, its property tax, its insurance and my property manager. Whatever is left stays in the operating account. All of it. For at least the first five years I own the house, I don't take a dollar of it out. Every single penny accumulates. But that's not the only thing.

That sits on top of $5,000 per property, held in the reserve account from the day I close. The account pays interest, about 4% at the moment, and the money does nothing most of the time, which is the point.

I own thirty properties right now, so there's never less than $150,000 sitting there. It's a whole lot more than that after the last three years of accumulation.

Right now, after what I experienced, I have so much cash in reserve that I could turn over every single property to a high standard if every tenant left tomorrow. If funding that $5,000 is what makes a deal impossible, I'd rather you didn't buy yet, and if the gap is small, there are honest ways to cut the cash to close that don't touch it.

Now, the honest test of the rule is the same turnover I priced above, landing at the end of year one.

So my $5,000 rule covers a bad first year, but only just.

In the worst case you're left with about $300 to find, and if the furnace had died in the same year you'd have been about $5,700 short. But then, as I already mentioned, all of my rentals get a full renovation with brand new systems from day one, so I'm not too concerned about that.

And if your first couple of years run well, by the end of year two the same house could hold up to around $20,000 in reserve (less any basic maintenance and repairs), and a turnover and a furnace in the same year are both covered with room to spare.

This bears repeating one more time. It is why I pay more for my houses than other investors do. I want a new roof, furnace, plumbing, electrics, A/C, windows and doors, because I'm trying to push the big capital costs further out and cut the number of things that can fail early. That makes ownership fairly low cost and hassle free for me, and creates a great living experience for my tenants. But a new roof doesn't stop a tenant leaving. I still keep the reserve.

Doesn't that mean the property pays me nothing?

For five years, yes. That's the point, and I know it puts some people off. Especially those who are looking to property as a way to build income. That still works, and it absolutely does.

If you're buying a rental for the $300 a month, I think you're making a big mistake, and I'd rather say so now than after you've bought. The first five years of owning a house are about accumulating capital inside it. You can certainly start to draw income down later, I do today, but I spent the last three years after my portfolio collapsed getting to this point.

Here's what that looks like on our example property if nothing goes wrong.

Of course, that's assuming there are no small repairs and maintenance to take care of, which there definitely will be. Things break when people live in houses, and you need to fix them. You also need to ensure your major systems are serviced and well-maintained in order to extend their useful life and reduce future repair bills. But all things considered, those things are fairly minimal on my properties.

Now let's use this illustrative example to run the version where things do go wrong.

The tenant leaves at the end of year one and the turnover costs $12,000. In year four the furnace dies, which sits inside the normal replacement schedule for a house of this age, call it $6,000. Both come out of the account.

At the end of year one the account holds $12,413, so the turnover takes it down to just a few hundred bucks. That's as close to empty as I'd ever want to run it, and it's the reason the floor exists. From there the account continues to accumulate, and there's still about $24,000 in the account at the end of year five.

Two bad events in five years, no money sent from home, and the mortgage was never missed. The tax and the insurance were paid on the day. Your tenant got a working furnace in a week rather than a month. There's a value in sleeping well at night, not having to worry about where you'll find $5,000 tomorrow morning. For me, that value is high.

That's the ride I want for my clients. One of them, Karl, bought his first US rental through me from Taiwan and hasn't touched the cash flow since. When the balance in his US account started to look meaningful he asked me what to do with it. Leave it there, I said. It's doing its job.

Need a new roof? The money's there. Tenant took three months to get out and the turnover cost $10,000? The money's there. (And if neither happens, you've got a very boring account balance and a very good problem.)

So where is the return, if it isn't the cash flow?

Ask any investor who's been doing this for ten years or more, who's lived through the property management headaches and held through more than one market cycle. They'll tell you the same thing. The real return is in building wealth, and it comes from three places.

I started buying in 2016, so I'm in my eleventh year. I've held through the 2020 shock, the 2021 and 2022 price run, the rate rise that followed, and my own collapse in 2023. These are the three things that have actually helped me to build wealth with rental properties.

The first is the mortgage paying itself down. The tenant's rent covers the loan, and every month a slice of the balance disappears. On our example property, year one, that's $1,306 of principal paydown, out of $10,209 of payments. It's math, not hope. And as you hold longer, the share of your monthly payment allocated to principal grows. That's how mortgage amortization works.

The second is the debt shrinking in real terms. The loan is fixed in the dollars of the day you borrowed. Every year of inflation makes those dollars worth a little less, so the same balance and the same payment become a smaller claim on a bigger asset. At 3% inflation, which is close to the long-run average of the US consumer price index, a $129,500 loan is worth about $3,772 less in today's money after one year. The direction of that is certain.

In my case, I took out DSCR loans of around $150,000 in 2023. Today, my loan balance is around $145,000, but in today's dollars after adjusting for inflation, it's worth about $133,000. The inflation effect is worth about $12,000 of real erosion on top of the $5,000 of paydown, so the loan is worth about $17,000 less in real terms than the day I took it out, on the consumer price index from September 2023 to August 2026.

The third is appreciation, and I put it last on purpose. It's the only one of the three that can go the other way. Over the long run US house prices have risen about 4.3% a year on the FHFA's index since 1991. In the year to the second quarter of 2026 they rose 2.1%. Some years they fall (although that's actually quite rare). I'd never buy a house on the assumption of appreciation, and I'd never tell a client to. I do try and buy in neighborhoods on a positive trajectory, and that's where the most appreciation tends to happen. But it's still a possibility, not a certainty.

Using the same property I mentioned that I refinanced with a $150,000 DSCR loan in September 2023, it appraised at $215,000 back then. It's worth about $245,000 today. Not huge growth, and it's only "on paper" money until I sell or refinance again, but it's $30,000 of wealth I built while sleeping.

Aside from the mortgage paydown, and the fact that you're using your cash flow to maintain the quality of your asset, the underlying driving factor here is inflation.

It's inflation that pushes up the asset value, and it's inflation that devalues the debt. So, if you believe inflation is here to stay, then owning leveraged real estate makes sense, provided you can hold it long term.

Let's go back to the illustrative example we've been using:

The number the buyer judged the deal on, 7.5%, is half the size of the real overall return. And it's the one they must not spend. There's a fourth effect too, the tax position, because a correctly filed US return on a rental often shows little or no taxable income once depreciation is claimed. That's a subject for my tax articles and a cross-border accountant, not for this page.

We just built the annual accounts for Karl, my client from Taiwan I mentioned above. He'll have received about $19,000 in gross rents by the end of 2026. His bank account is showing about $9,000, after all costs, and his US income tax bill will be about $280 for the whole year.

None of the three wealth drivers I mention above is cash flow. Not one of them pays a plumber. That's exactly why the cash flow has to stay in the house. It's the only liquid thing on the table, and it's what lets you hold long enough for the other three to compound. A fixed-rate DSCR loan held to term is the instrument that makes the second one work at all.

Then why does cash on cash return matter at all?

Because it's the screening test. It answers a different question from the one people use it for.

Here's how I reconcile the two halves of this article. When I underwrite a deal, I use percentages. Ten percent for vacancy, and around 20% for maintenance and capital together, on real tax and real insurance. If the deal still covers its debt after that, it passes. If it doesn't, I don't buy it, and cash on cash return is the right measure for that decision.

I can also use a cash amount based on my experience. I know for a fact that the rentals I own will cost me somewhere in the region of $2,000 to $3,000 per year to cover basic maintenance of major systems, periodic inspections, and day to day repairs. I know this because I've owned them a long time. So if my proforma with no reserves shows $6,000 in free cash flow before reserves, I know I can cover my costs, maintain my property, and add at least $3,000 to my reserve account by year end. Then I've got $8,000 total to play with.

Once I own the house, the percentages stop mattering, because averages don't pay invoices. Events do. So I retain everything until the reserve is big enough that an average year and a bad year look the same from my bank account.

Underwrite on percentages. Operate on retention. The $300,000 is the proof that you can get the first half right and still lose, if you get the second half wrong.

Run your own deal through my cash flow calculator with honest reserves and see whether it clears the first test. Then decide, before you buy, that you're going to ignore the number it prints for five years.

What about the lender's reserve requirement?

It's a different reserve, sized for a different risk, and it's not the one I've been describing.

Most foreign national lenders want to see cash reserves in a US account at closing, anywhere from three months of mortgage payments up to twelve. The specialist lender I work with asks for three. Others are much higher than that. That money stays yours. It's never a cost. But it's there to satisfy the lender that you can carry the loan if rent stops, and it's sized for their exposure, not for your furnace.

So don't count it twice. The lender's three months is not the $5,000, and it's not the retained cash flow. It's the floor beneath both. What a non-resident actually brings to the table covers how the three fit together on a real closing statement.

What would I do, in order?

Screen the deal on honest percentages, with real tax and a real insurance quote, and walk away from anything that only works at the seller's figures.

Fund the $5,000 before you close, not after. If you can fund the purchase but not the reserve, buy next year.

From the first month, let the house pay its own bills and leave the rest where it lands. Don't touch it for five years. If you want a figure for what "the rest" should add up to, hold at least one full turnover in cash on top of the floor, which on these numbers is about $10,000 a house.

Keep the reserve in an interest-bearing US account that you control, not with the property manager. One month's rent with the manager is enough for them to act quickly.

Review at year five. By then you'll know your house, your tenant pattern and your market, and you can decide what the right floor is from there.

And buy the right house in the first place. A property with new systems in a neighborhood on the way up gives you fewer events to fund. That's the sourcing work I do for clients, and the foreign investor starter kit has the reserve checklist free.

The bottom line

Cash flow is the number everyone looks at, and it's the number you must not spend. Not for five years, anyway.

I know how that sounds to someone who was promised $300 a month. But I've been the person who spent it. I had $300,000 set aside at 20% and it wasn't enough, because the money that would have saved me was the money I'd already taken out. The percentage wasn't the mistake. The way I managed my money was.

So my advice is the dull version. Underwrite on honest numbers. Then treat every dollar the house produces as the house's money, not yours, until it has enough in the bank to shrug off a bad year.

Your return is coming from the mortgage paying down, the debt shrinking in real terms, and, if you're patient and the market's kind, the house being worth more. The cash flow is what keeps you in the game long enough to collect all three.

None of that guarantees anything. A reserve doesn't stop the roof failing, it just stops the roof failing you. Investing is a game of probabilities, and keeping the cash flow in the house is the cheapest way I know to tilt them.