When it comes to investing in Airbnb rentals, the goal of every real estate investor is to find investment properties for sale that promise a high return on investment. And to find out if an investment property yields a high return, investors resort to calculating several metrics that help them measure its performance. One of these metrics is the cap rate.
What exactly is cap rate? How is it calculated? What is a good cap rate for an Airbnb rental property? Keep reading to learn the answers to all these questions.
What Is Cap Rate?
Let’s start off by defining cap rate. The cap rate (or capitalization rate) is one of the most commonly used metrics to measure the rate of return on investment or the profitability of an investment property. What makes it such a popular metric in the real estate investor community is that it measures the rate of return regardless of the property’s method of financing.
Related: Return on Investment: The Metrics Used in Real Estate Investing
Theoretically, the cap rate is a measurement of the level of risk involved in buying an investment property. A low cap rate indicates a low level of risk, whereas a high cap rate indicates a high level of risk. Generally speaking, the higher the cap rate, the better it is for an investor. Why? Because, in real estate investing, low levels of risk are linked to low profitability, while high levels of risk are associated with high potential for return.
Of course, this is not always the case. Many times, a low cap rate property can make for a good real estate investment. If it promises positive cash flow and is within the investor’s budget, a low cap rate property may be better than a high cap rate one. Let’s take a closer look now at how to conduct a cap rate analysis.
How to Calculate Cap Rate
Before answering what is a good cap rate for an Airbnb rental property, let’s first see how the cap rate is calculated.
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Cap Rate Formula
The cap rate formula is as follows:
There are two main components of the cap rate formula.
The first one is the Net Operating Income (NOI): this is the annual income that is expected to be generated by the Airbnb rental property. It is calculated by subtracting the rental expenses from the gross rental income.
The rental expenses are basically all the costs associated with owning, managing, and renting out the Airbnb rental, such as utilities, taxes, insurance, maintenance, repairs, management costs, etc. Note that financing costs (e.g. mortgage payments, debt service) do not count as rental expenses here and are excluded from the cap rate formula.
The second component is the Fair Market Value (FMV): this is the current value of the investment property on the open market. In principle, FMV is similar to the property’s selling price.
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Cap Rate Calculation Example
To have a better understanding of how the cap rate formula is used, let’s have a look at a quick example.
A real estate investor purchases an Airbnb rental property for $200,000 and decides to rent it out on Airbnb for $70/night. The Airbnb occupancy rate in the area is 60% according to Airbnb analytics.
In this case, the annual rental income which is expected to be generated by the Airbnb property is:
Rental Income = $70 x 365 days x 60% = $15,330
Assuming that the rental expenses account for 20% of the total rental income (i.e. $3,066), the net operating income is:
NOI = $15,330 – $3,066 = $12,264
The property’s cap rate is, therefore, equal to:
Cap Rate = ($12,264 / $200,000) x 100% = 6.1%
Is 6.1% a good cap rate? We’ll answer this question very soon. But first, you need to know that there’s a better way to calculate the cap rate.
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Cap Rate Calculator
A quick and more efficient way to determine the cap rate for an Airbnb rental is to use a cap rate calculator. This is an innovative tool that uses Airbnb data and predictive analytics to provide real estate investors with a reliable estimate of the cap rate for any Airbnb rental property for sale in the US.
One of the best cap rate calculators out there is Mashvisor’s calculator. It can actually turn months of research into a mere 15 minutes by optimizing Airbnb real estate market analysis and Airbnb investment analysis. It can be used to analyze Airbnb cap rates by city (this data can be found for free on our blog).
More importantly, you can use it to calculate individual Airbnb property cap rates in the real estate market of your choice. The cap rate calculator is a must-have tool if you are considering buying Airbnb property. You can check it out here.
Related: What Is Mashvisor? What Can It Do for Real Estate Investors?
What Is a Good Cap Rate?
Now that you know what a cap rate is and how to calculate it, we can finally address the long-awaited question: what is a good cap rate for an Airbnb rental property? Generally speaking, a good cap rate for investment properties in the US is usually somewhere between 8% and 12%.
However, there isn’t really a way to exactly pinpoint what a good cap rate for a rental property is. That’s because the range of good cap rate is actually dependent on many different factors. Here are some of the main factors that affect cap rates:
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Location
As you probably know, location determines each and every aspect of a real estate property. It should, therefore, come as no surprise that location also determines the average cap rate for an Airbnb rental property. City-centers and metro areas tend to have lower cap rates than suburban and rural areas.
This is mainly due to the fact that urban locations typically have significantly higher property prices than rural locations. So, what may be considered a good cap rate in a city-center will actually be lower.
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Property Type
Another factor that affects what is considered a good Airbnb cap rate is the property type. There are many different types of properties a real estate investor can invest in, and each type has a different cap rate. For instance, multi family rentals generally have higher cap rates than single family homes.
The reason behind this is that multi family homes generate more income on average than single family homes. As a result, what may be considered a good cap rate for single family rentals will be lower.
Related: What Is a Good Cap Rate When Investing in Multi Family Homes for Sale?
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Interest Rates
Interest rates are another important factor that influences what is a good cap rate and a good ROI for vacation home rentals. When interest rates in a real estate market increase, cap rates tend to increase as well. Why?
Well, as interest rates rise and debt services become more expensive, investors are forced to pay less for income properties to be able to achieve a decent real estate return on investment. Property sellers are, in turn, forced to lower their prices, which causes the cap rates to go up.
The Bottom Line
There is no straightforward answer to the question “What is a good cap rate for an Airbnb rental property”? Real estate investors must weigh their options and take into account all the different factors mentioned above when looking at cap rates and decide whether a certain rental property is worth investing in.
If you are a beginner investor looking to buy your first Airbnb rental, it is recommended that you start your real estate search using a cap rate calculator so that you can find good cap rate properties more easily. Sign up for a 7-day free trial with Mashvisor to get your hands on our cap rate calculator.