How To Estimate The Profit Potential Of A Short Term Vacation Rental
Before investing in a hospitality property like a short-term vacation rental, it’s important to calculate the return on your investment. There are three key figures you will need to determine to define the profit potential of a hospitality rental. These include cash flow, cap rate, and cash on cash return. Here is our simple guide to calculating these important figures before investing in a new short-term vacation rental.
1. Define Your Cash Flow
Cash Flow is the net amount of cash being transferred in and out of the short-term vacation rental. Calculating cash flow is simple. Take your monthly rental income projection minus the monthly operating expenses. For example, if you plan to rent a vacation rental at $200/night. Full occupancy would mean $6000/month. Say your overhead costs are estimated at $1,000 for maintenance, marketing, and admin. That is your NOI. Your cash flow at full occupancy would be:
$6000 (Monthly Rental Income) - $1000 (Monthly NOI) = $5000 (Monthly Cash Flow)
$72,000 (Yearly Rental Income) - $12,000 (Yearly NOI) = $50,000 (Yearly Cash Flow)
2. Calculate Your Cap Rate
The Cap Rate is the financial return of a real estate investment over a year. It is usually determined to see if the investment is sound. Cap rate the NOI divided by the price of the short-term rental. Imagine you paid $200,000 for the building. In that case, your cap rate calculation would be:
6% (Cap Rate) = $12,000 (Yearly NOI)/ $200,000 (Purchase Price)
Experts agree that a good cap rate for short-term hospitality rentals is between 5-10%.
3. Determine Your Cash On Cash Return
Calculating the Cash on Cash Return is similar to calculating the Cap Rate. However, instead of dividing NOI by the rental’s full value. You will instead use the actual money you will be paying for the building. For example, say you put down 15% or $30,000 when purchased. Then you pay a monthly mortgage figure of $1,000. Add that to your $1,000 operating and overhead costs, making the NOI now $2,000.
6% (Cash on Cash Return) = $2,000 (NOI)/$30,000 (Actual Cash Investment)
Experts agree that good cash on cash on a short-term hospitality rental return falls between 6-12%.
Once you have these figures calculated, you can determine if the short-term hospitality rental is a good investment. For more information about how to assess and acquire hospitality rentals, contact Occupancy Solutions. We can help you do a deep dive into the financials and determine how to maximize revenue from your rentals.