Is buying a rental property actually a good investment?

Rental property returns come from four sources: rental income after expenses, appreciation, principal paydown by tenants, and tax benefits including depreciation. The mistake in most amateur analysis is treating gross rent minus mortgage payment as profit. Realistic expense modeling includes property taxes, insurance which is higher for rentals, maintenance commonly estimated at one to two percent of value annually, capital expenditures for roofs, HVAC, and appliances that must be reserved for even in years nothing breaks, vacancy allowance of five to ten percent, property management at eight to twelve percent of rent if you are not doing it yourself, and legal and accounting costs.

Two screening tools are widely used and both are rough. The one percent rule suggests monthly rent should approach one percent of purchase price, which is difficult to find in expensive markets and is a starting filter rather than an analysis. Capitalization rate divides net operating income by purchase price and permits comparison across properties, though it excludes financing. The more complete measure is cash-on-cash return, dividing annual pre-tax cash flow by the actual cash invested, which reflects what leverage does. Leverage amplifies both directions, and a property with thin margins becomes a monthly loss when a tenant leaves or a furnace dies.

The parts people underestimate are operational rather than financial. Tenant screening, maintenance calls, turnovers, and the eviction process when it becomes necessary are real work with real legal exposure, and landlord-tenant law is strict about procedure and unforgiving of improvisation. Concentration risk is significant, since a single property in one market is the opposite of diversification. Liquidity is poor, since selling takes months and costs a substantial percentage. The honest comparison is against a REIT index fund, which provides real estate exposure with liquidity, diversification, and no tenants, and which many investors would be better served by. Direct ownership can beat it, principally through leverage, tax treatment, and the ability to add value actively, but it earns that return with work and risk rather than by being real estate.