Most rental deals do not fall apart on the purchase price. They fall apart on a number the buyer never ran.
We have owned multifamily in Southern California for more than 15 years, and the pattern holds: the surprise is rarely the price you negotiated. It is the vacancy you did not budget, the capex you did not reserve, or the rents you assumed instead of verified. Cash flow is where all of that shows up. Here is how we analyze it, in the order that actually matters.
Start with the goal, not the listing
Before any math, answer one question: what is this property supposed to do for you? Monthly cash flow, appreciation over a hold, a tax-deferred home for a 1031, or a value-add you reposition and refinance. The answer changes which numbers you weight. A buyer chasing cash flow today reads a deal very differently than one buying for a 10-year hold.
Actual rents, not asking rents
The most common mistake we see is underwriting a building on pro forma rents, the rents a seller says you could get. Pro forma is a hope. Actuals are a fact. Underwrite the actuals, then treat the gap to market as upside you have to earn, not income you already have.
If a fourplex collects $2,200 a unit today and the broker says it should get $2,800, that $600 spread is a project: turnovers, renovations, time, and in many Los Angeles submarkets, rent-control limits on how fast you can move existing tenants toward market. Price the building on the $2,200.
Build the NOI honestly
Net operating income is annual income minus annual operating expenses, before your loan payment. It is the engine of cash flow, so build it honestly.
Income is gross scheduled rent plus real ancillary income (laundry, parking, storage), minus a vacancy allowance. Underwrite vacancy even in a tight market. We use a floor of 5% in strong LA submarkets and more where turnover runs hot.
Operating expenses are where deals get oversold. Count all of them:
- Property taxes, reassessed in California at roughly 1.25% of your purchase price, not the seller’s old basis. This one quietly breaks more underwrites than any other.
- Insurance, which has moved sharply in California. Get a real quote.
- Repairs and maintenance.
- Property management, even if you self-manage. Budget 6 to 8% so the deal stands on its own.
- A capex reserve, usually $250 to $500 per unit per year, for roofs, systems, and turns.
- Utilities you cover, landscaping, pest, and any HOA.
The reserve and the management line are the two people skip to make a deal look better. Skipping them does not make the costs disappear. It moves the surprise to after closing.
Cash flow is where financing meets reality
NOI ignores your loan. Cash flow does not. Cash flow is NOI minus debt service, your annual mortgage payments. This is the number that lands in your account, and it is where today’s rates do real damage.
Two numbers to watch:
- DSCR (debt service coverage ratio): NOI divided by debt service. Lenders want it above roughly 1.20 to 1.25 on multifamily. A DSCR of 1.25 means the building earns $1.25 for every $1.00 of loan payment, a 25% cushion before you feed the property from your own pocket.
- Cash-on-cash return: annual pre-tax cash flow divided by the cash you put in. This tells you what your invested dollars actually earn.
A worked example
Say a Mid-City Los Angeles fourplex is listed at $1,200,000.
- Actual rents: 4 units at $2,200 = $8,800 per month, $105,600 per year.
- Vacancy at 5%: minus $5,280. Effective income: $100,320.
- Operating expenses, built honestly: property taxes about $15,000, insurance $6,000, repairs $6,000, management at 7% about $7,000, capex reserve $1,600, utilities and grounds $5,000. Total about $40,600.
- NOI: $100,320 minus $40,600 = $59,720.
Now finance it. Put 25% down ($300,000) and borrow $900,000 at 6.5% on a 30-year amortization. Annual debt service is roughly $68,300.
- Cash flow: $59,720 minus $68,300 = about negative $8,600 a year.
- DSCR: $59,720 divided by $68,300 = 0.87. Below 1.0, so the building does not cover its own loan, and most lenders will not write it.
This is a common outcome in Los Angeles right now: a respectable yield that still does not cash flow at today’s borrowing costs. The deal is not dead. It can work with more down, a lower price, a better loan structure, or a credible plan to move those rents toward market. But you make that call with the math in front of you, not after the close.
Stress the deal before you sign it
A deal that only works under perfect conditions is not a deal. It is a bet. Run three quick sensitivities. What happens to cash flow if rates rise 50 basis points before you lock. What happens if you carry one extra month of vacancy per unit per year. What happens if insurance comes in 20% over quote. If any one flips the deal from workable to underwater, you have found your risk before it found you.
What the spreadsheet will not tell you
The model gets you most of the way. The last stretch is judgment. Does the submarket hold rents in a soft year. Is there deferred maintenance priced as cosmetic. Does the rent roll match the leases, or just the listing. Confirming those is the heart of real due diligence, and it decides whether your underwrite survives contact with reality.
Cash flow is one lens. Cap rate is the other, and we cover it in detail in our guide to cap rate in Los Angeles real estate. Read them together before you write an offer.
The bottom line
Underwrite the actuals. Build the NOI with every cost in it, including the ones that are easy to leave out. Run cash flow and DSCR against real financing, and stress the deal before you sign it. If the numbers work, you will know, and you will know why.
If you are weighing a Los Angeles rental and want a second set of eyes on the underwrite, talk to us before you write the offer. That is the conversation worth having.