Rebuilding the Seller's Pro Forma: How to Recalculate NOI, Cap Rate, and Cash-on-Cash When the Rental Numbers Look Too Good

Why the Listing's Cap Rate Is a Sales Pitch, Not a Number

A duplex hits the market at $285,000 with "10.5% cap rate" in bold on the flyer. Run the math backward and the seller is claiming $29,925 in annual net operating income, or about $2,494 a month from two units. In most markets that looks like a deal worth calling about immediately. Before you dial the agent, ask a simpler question: whose expenses produced that number?

Start with the definitions, because the seller is using the same ones you are. Net operating income (NOI) is effective gross income (rent actually collected after vacancy and credit loss, plus other income like laundry or parking) minus operating expenses. It excludes debt service, so NOI shows how the property performs no matter how you finance it. Cap rate is NOI divided by price, so $29,925 / $285,000 = 10.5%. Cash-on-cash return is annual pre-tax cash flow (NOI minus mortgage payments) divided by your total cash invested, including down payment, closing costs, and any upfront repairs.

The formulas are honest. The inputs usually aren't. Seller pro formas tend to assume 100% occupancy and include only the bills the seller personally paid last year. These are the line items that most often go missing:

• Vacancy and credit loss, commonly underwritten at 5% to 8% of gross rent
• Routine maintenance and repairs
• Capex reserves for roofs, HVAC, water heaters, and flooring
• Property management, usually 8% to 10% of collected rent, even if you plan to self-manage
• Owner-paid utilities such as water, sewer, and trash, which are common on duplexes
• Property taxes that reassess to your purchase price after the sale

Each omission looks minor on its own. Together they can pull $10,000 to $12,000 a year out of NOI on a property this size, which drags that 10.5% cap rate down into the 6% to 7% range. The listing number isn't exactly a lie. It's the best-case figure the seller wants you to anchor on, so treat it as the starting point for your own underwriting, not the conclusion.

Worked Example 1: Rebuilding NOI Line by Line on a $285K Duplex

Here is the listing: a duplex asking $285,000, with two units renting at $1,450 a month each, for $34,800 in annual gross rent. The seller lists only two expenses, $3,600 in property taxes and $1,400 in insurance, for $5,000 total. That produces an NOI of $29,800 ($34,800 minus $5,000) and a cap rate of 10.5% ($29,800 divided by $285,000). On paper, it looks like a rare find.

Start rebuilding at the top line. No rental stays full forever, so apply a 6% vacancy and credit loss: $34,800 x 0.06 = $2,088. That leaves effective gross income (EGI) of $32,712. This is the real income figure, and the seller's pro forma skipped it entirely.

Now replace the seller's expenses with numbers you can defend:

• Taxes: $4,800. Pull the millage rate from the county assessor's website and apply it to your purchase price. Many counties reassess on sale, so the seller's $3,600 likely won't survive closing.
• Insurance: $1,800. Get a real landlord policy quote for the address, not the seller's current premium.
• Maintenance: $2,784 (8% of $34,800 gross rent).
• CapEx: $2,436 (7% of gross rent) for roofs, HVAC, and water heaters.
• Management: $2,944 (9% of $32,712 EGI), even if you self-manage, because your time has a cost.
• Water/sewer: $1,200. Request 12 months of utility history from the seller or the utility company, since owners often pay water on small multifamily.

Those six lines total $15,964. Subtract them from EGI: $32,712 minus $15,964 equals a true NOI of $16,748. Divide by the asking price: $16,748 / $285,000 = a 5.9% cap rate. Same building, same rents, a completely different deal.

Nothing about the property changed here, only the honesty of the inputs. The seller's version overstated NOI by $13,052, nearly 44% of their claimed figure. At 5.9%, this duplex is an ordinary deal at best, and that gap is exactly what you'd be overpaying for if you trusted the listing.

Worked Example 2: Adding Financing and Solving for the Price That Works

Now add a loan to the duplex. At the $285,000 asking price, 25% down is $71,250. Closing costs at 3% add $8,550, and a $5,000 make-ready budget brings your total cash invested to $84,800. The remaining $213,750 loan at 7.25% over 30 years costs about $1,458 a month, or $17,497 a year.

Your rebuilt NOI has to cover that payment, and it falls short. Subtract $17,497 in debt service from $16,748 of NOI and you get -$749 a year. Divide by $84,800 and cash-on-cash comes out to about -0.9%. You would be paying roughly $62 a month to own a property the listing called a cash cow.

Next, work backward to find the price that works. At 75% loan-to-value, annual debt service equals about 6.14% of the purchase price (0.75 x 12 x the monthly payment factor of 0.0068218). Break-even is where NOI equals debt service, so divide $16,748 by 0.0614 and you get roughly $272,800. A 3% cash-on-cash target is a stricter test, because cash flow must equal 3% of your cash invested (0.28 x price + $5,000). Solving that equation gives about $238,000. To check it: $71,640 in cash, $14,612 in debt service, and $2,136 in cash flow produce a 2.98% return.

Those two numbers become your offer strategy. Submit $238,000 with a one-page summary showing the rebuilt expense lines, the debt service, and the resulting return. A seller can wave off a lowball number, but arithmetic is much harder to dismiss. If they counter, you already know your ceiling, because anything above $272,800 means you pay out of pocket every month to hold the property.

In a spreadsheet, this process can eat an hour per property. FlipSmrt shortens it. Paste the address, and it returns cap rate, cash-on-cash, and the rest of the deal math alongside comparable sales. From there, you can adjust the down payment, rate, or price and watch the return update before you write a single offer.

Nuances: Taxes, Rent Upside, Reserves, and Hold vs Flip

The seller's tax line reflects their assessment, not yours. Reassessment rules vary widely by state. Some reset the taxable value to the purchase price at sale, some reassess on a fixed cycle, and some cap annual increases. If the seller pays $2,900 on an old assessment and your county's effective rate is 1.4%, a $285,000 purchase could push taxes to $3,990. That is a $1,090 cut to NOI, so call the assessor's office before you trust the listing.

"Rents are $200 below market" is real upside only when leases turn over. If both units are leased through next August, your year-one NOI uses current rents, period. Model the higher rent starting in year two. Subtract the turnover costs and the vacancy month it takes to capture it. If you pay today's price for tomorrow's rent, you hand the seller your profit.

Reserves should match the building's age. A flat 5% capex line works for a recently updated property, but an 18-year-old roof and original furnaces call for more. Suppose you expect a $12,000 roof and two $7,000 furnaces within five years. That's $26,000 divided by 5, or $5,200 a year in reserves. On a duplex, that can wipe out most of the cash flow.

Cap rates also mean different things by property type. Lenders and buyers value two- to four-unit buildings partly on income, so cap rate shapes the price. Single-family homes trade on owner-occupant comps, so a cap rate there is only a yield check. Don't use it to justify the price.

Finally, compare a thin hold against your other exits. Say you invest $70,000 for a 3% cash-on-cash return, or $2,100 a year. On a $228,000 loan at 7%, year-one principal paydown is roughly $2,300, which brings you to about 6.3% before appreciation. That trade can make sense in a steadily appreciating market if you have reserves to absorb a vacancy. It doesn't if cash flow turns negative after realistic reserves, or if flipping or wholesaling the same property would net $30,000 in six months.

Common Mistakes When Checking a Rental's Returns

Bad rental purchases rarely come from one huge error. They come from small shortcuts that each push the return up a point or two. Run through these six checks before you trust any cap rate or cash-on-cash figure, including your own.

The first two mistakes happen at the top of the math. Investors subtract the mortgage payment before calculating NOI, which mixes financing into a number meant to describe the property alone. The fix is simple: NOI is income minus operating expenses, and debt service comes out later when you calculate cash flow. The second error is starting from gross scheduled rent instead of effective gross income. Subtract vacancy and credit loss first, so $3,000 a month at 6% vacancy becomes $33,840 of EGI, not $36,000.

Next comes the expense side. Leaving out capex because "nothing is broken" ignores that roofs, water heaters, and HVAC systems wear out on schedule whether they're failing today or not. Budget a fixed reserve, such as $250 a month for a duplex, and treat it as a real cost. The related mistake is valuing the property at the seller's cap rate. Use the cap rate that comparable properties actually trade at in that submarket, because the seller's figure rests on their own optimistic NOI.

The last two errors hit the return calculation and the data behind it. Cash-on-cash divides annual cash flow by total cash invested, meaning down payment plus closing costs plus make-ready spending. With $4,500 of annual cash flow, a $57,000 down payment alone shows 7.9%, but adding $9,000 in closing costs and $6,000 in turnover work drops it to 6.3% ($4,500 / $72,000). Finally, never accept a rent roll on its own. Ask for signed leases, security deposit records, and a few months of bank deposits that match the stated rents.

Each fix takes minutes, and together they turn a seller's pitch into a number you can actually underwrite. Rerun your figures after every correction so you can see exactly which assumption was carrying the deal.

FAQ: Rebuilding Rental Pro Formas

What vacancy and maintenance percentages are reasonable starting points? Many investors start with 5-8% of gross rent for vacancy and 5-10% for maintenance, then add a separate capital expenditure reserve for roofs, HVAC, and water heaters. Push toward the high end for older buildings or soft rental areas. On a duplex grossing $28,800 a year, 7% vacancy is $2,016 and 8% maintenance is $2,304. That is $4,320 the seller's pro forma probably left out.

Should you include management if you plan to self-manage? Yes, always. Budget 8-10% of collected rent, which is $2,592 a year at 9% on that same duplex. Your time has real value, and any future buyer or lender will underwrite a management fee whether you pay one or not. If the deal only works when you work for free, you bought a job, not an investment.

How do you verify a seller's rent and expense claims? Ask for documents, not summaries. Request this short list:

• Current rent roll and signed leases
• 12-24 months of bank statements showing actual rent deposits
• Schedule E from the seller's tax returns
• Utility bills and the latest property tax bill from the county

Then get your own insurance quote and check rents against nearby comparable rentals. When the deposits don't match the rent roll, believe the deposits.

What cash-on-cash return is worth holding for, and does a negative one ever make sense? Many buy-and-hold investors look for roughly 8-12% cash-on-cash, accepting less only for strong appreciation or a low-effort property. A negative return can make sense in narrow cases, such as below-market leases expiring within six months or a funded value-add plan, as long as you hold reserves to cover the shortfall. Betting on appreciation alone is not a plan, so treat it as a red flag.

The rule behind every answer here is simple. Never price a rental off the seller's NOI. Rebuild income and expenses line by line with your own assumptions, recalculate cap rate and cash-on-cash, and let your offer come from your numbers, not theirs.