When it comes to investing in vacation home rentals, we all aim for the highest return on investment. There are several ways to measure the performance of real estate investment properties, and in this blog, we will look in depth at one real estate metric in particular: the cap rate. So, what is it and what is a good cap rate for vacation home rentals?
Investing in Vacation Home Rentals: The Essentials
In real estate terms, vacation home rentals are short term rentals that are rented out for a short period of time, usually less than 30 days. The success of online booking platforms such as Airbnb, VRBO, and HomeAway has encouraged real estate investors to put their money in short term rentals like never before. Compared to the traditional long term rental strategy, an Airbnb investment offers more advantages given the right circumstances.
Related: The 7 Best Places to Buy a Vacation Home in Florida
First, vacation home rentals generate higher returns than traditional rentals. A lot of this has to do with the fact that short term rentals are priced per night and not per month, which allows property owners to charge higher rates. Furthermore, our data analytics at Mashvisor show that for most neighborhoods and cities across the US, cash on cash return and cap rate are higher when a property is used as a short term rental rather than a long term traditional one.
Second, there has never been a better moment to invest in vacation home rentals than now. With a fast-growing market and several booking platforms, finding tenants for your short term rental is easier than ever. All you have to do is find a property in a good location and evaluate its performance as a real estate investment.
When talking about investing in vacation home rentals, one cannot neglect the importance of location. Location of the investment property determines its ability to attract vacationers and tourists, who are the primary tenants of short term rentals. Conducting real estate market research will give you an idea about the performance of an investment in a particular area.
Moreover, an investment property analysis provides you with important real estate metrics and indicators like cash on cash return and cap rate. This brings us to our main question, what is a good cap rate for vacation home rentals? To answer this question, let us first talk a little about the cap rate and how it is calculated for vacation home rentals.
What Is Cap Rate? How Is It Calculated for Vacation Home Rentals?
Short for capitalization rate, cap rate is a rate of return indicator based on how much income an investment property generates. Cap rate is an important real estate metric that has many uses:
- First, the cap rate tells you whether you are buying an investment property at a good price.
- Second, you can use cap rate to valuate a real estate property using the income approach method. In this method, the value of a real estate property is calculated based on cap rates of recently sold comparable properties.
- Finally, knowing the cap rate of your investment property allows you to determine how much rent to charge your tenants.
Cap rate is calculated using the cap rate formula:
Cap Rate = Net Operating Income (NOI) / Market Value of Property
Before answering what is a good cap rate for short term rentals, let us show you an example of calculating cap rate for an Airbnb investment. Note that estimating the net operating income for short term rentals is far more complicated than that of traditional long term rentals. The reason for that is fluctuations in the short term housing market which typically dependent on tourism. However, at Mashvisor, we have the solution for that. Our Airbnb profit calculator is a great tool that provides you with occupancy rate and Airbnb rental income for investment properties in all neighborhoods and cities around the US.
Example: You buy an Airbnb investment for $200,000. You list it on Airbnb for $70/night. Airbnb analytics from Mashvisor tell you that in that area, the occupancy rate for short term rentals is around 50%.
Airbnb Rental Income: $70 x 365 days x 50% = $12,775
Assume 15% management and operating fees. Net Operating Income: $12,775 – $1,915 = $10,860.
Cap Rate: $10,860/$200,000 = 5.43%
What does this answer mean? Is this a good cap rate? If not, what is a good cap rate?
What Is a Good Cap Rate for Vacation Home Rentals?
Cap rate for vacation home rentals fluctuates significantly from month to month and even year to year. That’s why when investing in a short term rental, you need a healthy and high cap rate in order to offset market fluctuations.
In theory, higher cap rates imply high risk and vice versa. But to really understand what is a good cap rate for vacation home rentals, you need to consider these 3 factors.
Related: What’s a Good Cap Rate for Investment Properties?
1. Location: The location of a short term rental is the main driver for demand. An Airbnb investment in a well-located neighborhood will have a higher cap rate. However, high cap rates are not always the best option since they correspond to higher risk. Be sure to investigate all risk factors to ensure a high cap rate is good for the particular location.
2. Property type: Different types of investment properties have different cap rates and different levels of risk.
3. Interest rates: When interest rates rise, property value falls and therefore cap rates rise. This is not always a good thing since higher interest rates mean higher debt cost and less cash in your pocket.
The Bottom Line
The answer to “what is a good cap rate for vacation home rentals” has no definitive answer. As mentioned above, a good cap rate is subjective to the location, property type, and cost of borrowing. However, real estate experts say that anything between 8% and 12% is worth investing in.
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