Guides · Rentals · 7 min read
How to underwrite a rental like a lender — net operating income, DSCR, cash-on-cash and cap rate, plus the operating expenses that turn a 'cash-flowing' property negative.
When a lender evaluates a rental, the question is not what you earn — it is whether the property pays its own debt. That is DSCR, the debt service coverage ratio:
DSCR = Net Operating Income ÷ Debt Service
Above 1.00, the property covers its mortgage. At 1.20 — the common threshold — it covers it with twenty percent to spare. Below 1.00, you are funding the difference every month, whether the spreadsheet said so or not.
Net operating income is where most amateur underwriting goes wrong, because it is where expenses get quietly omitted. The full stack:
| Line | Typical assumption | Why it is missed |
|---|---|---|
| Gross rent | Market rent, verified by comparable listings | Often set at the optimistic end |
| Vacancy | 5–8% of gross | Assumed to be zero because "it's rented now" |
| Property taxes | Actual bill, reassessed after sale | Prior owner's assessment is used |
| Insurance | Landlord policy, current quote | Quoted as owner-occupied |
| Management | 8–10% of collected rent | "I'll manage it myself" — until you don't |
| Maintenance | 5–8% of rent | Treated as occasional rather than continuous |
| CapEx reserve | 5–10% of rent | Omitted entirely — the most common error |
| Utilities / HOA | Whatever the owner pays | Assumed tenant-paid without checking the lease |
Note what is not in NOI: the mortgage payment. NOI measures the property; debt service is how you financed it. Mixing them produces a number that means nothing to a lender.
A property can show a healthy cap rate and still be uninvestable at today's rates, because cap rate ignores debt. Run all four on the rental cash flow and DSCR calculator before you make an offer.
Take your underwriting and break it deliberately:
A deal that survives all five is a deal worth owning. A deal that only works when nothing goes wrong is a job, not an investment.
Many rentals worth owning are not financeable in their current condition — which is the entire logic of the BRRRR sequence: acquire and renovate with short-term capital, stabilize with a tenant in place, then refinance into long-term debt once the property qualifies. Underwrite that takeout refinance before you buy, at today's rates and today's DSCR requirements, not at the numbers you hope for. Model how much capital comes back with the BRRRR calculator, and see where renovation budgets leak before you set the rehab number.
Send the address, the budget, and the timeline — you will get a straight answer, not a maybe.
Submit a ProjectMost DSCR lenders want at least 1.20, meaning net operating income covers the debt payment 1.2 times. Some programs allow 1.00 or slightly below with pricing adjustments and more equity. Below 1.00 the property does not pay for itself and you are subsidizing it monthly.
Net operating income divided by debt service. NOI is effective gross income (rent less vacancy) minus operating expenses — taxes, insurance, management, maintenance, reserves, HOA and utilities you pay — but NOT the mortgage payment. Debt service is principal and interest, and some lenders include taxes and insurance.
Capital expenditure reserves, vacancy, and management. A roof, a heating system, and a turnover between tenants are certainties spread across years, not surprises. Underwriting without them produces a number that looks like cash flow and is really deferred cost.
No. The 1% rule (monthly rent equal to 1% of purchase price) is a screening shortcut from a lower-rate era. It ignores taxes, insurance, condition, and interest rates, all of which vary enormously by market. Use it to sort a list, then underwrite the ones that survive.
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