Owning a vacation rental property has become an increasingly popular strategy for making money in real estate. Platforms
like Airbnb, Expedia, HomeAway, Hotels.com, Booking.com, and HometoGo have made booking short-term rentals very simple, thus motivating people to choose them over hotels during travel. According to statista.com, revenue in the US short-term rentals segment is expected to hit $13,324 million in 2021. By 2025, the revenue is expected to grow to $19,904 million. Though the vacation rental industry experienced a major blow due to the Coronavirus pandemic, it is recovering very fast as economies reopen.
Before we look at how to estimate a vacation rental potential, let us consider some of the benefits of owning a vacation rental investment:
- Extra income – According to CNBC.com, Airbnb hosts make about $924 per month. Mashvisor’s nationwide real estate market analysis shows that this income can vary greatly depending on the quality of your rental, how often you rent it out, where it is located, and the services you provide. Nevertheless, on average, short-term rental properties offer more income than traditional ones.
- Tax deductions – Owning a short-term rental means that you can deduct many of the costs you incur while running your business. Some of the expenses you can write off include cleaning costs, occupancy taxes, utility costs, supplies, insurance premiums, mortgage interest, property management fees, and lawn maintenance.
- Appreciation – Real estate typically increases in value over time. This means that you are likely to make a profit when you decide to sell your investment property.
- Free holiday spot – Besides renting it out and making money, you can also enjoy free accommodation whenever you want to take a vacation by yourself, or with friends and family. This is why it would be advisable to buy a vacation rental in an area that you can access easily and where you enjoy spending time.
- A nest egg for retirement – A vacation rental can be a great source of passive income during retirement. You could even choose to sell it and use the cash for your costs of healthcare, travel, and more.
How to estimate vacation rental potential
Let’s say you have already done your research and identified a condo, single family home, apartment, or multifamily home that you are thinking of buying. How do you estimate the potential of a vacation rental investment before making a purchase decision? How can you tell whether you will make a good ROI for vacation rentals?
Here are some numbers that will help estimate a vacation rental’s potential:
Merely listing your vacation home on Airbnb does not guarantee that you will generate profits. To make money on vacation rental property, you will need to get bookings and maintain a good occupancy rate. This is why it is important to measure vacation rental occupancy rate before buying. The formula for Airbnb occupancy rate is as follows:
Airbnb occupancy rate = The number of booked nights/The number of total available nights
When it comes to a vacation rental’s potential, what would be considered a good Airbnb occupancy rate? Most people would think that the best vacation rental is the one with the highest occupancy rate. However, higher occupancy rates don’t always translate into more profits. A good occupancy rate is that which allows the host to charge an average rental rate that maximizes vacation rental income.
Cash flow is another popular metric for evaluating vacation rental potential. Here is the formula for calculating cash flow:
Cash flow = Monthly rental income minus Monthly rental expenses
Expenses include things like property tax, mortgage payments, property insurance, HOA fees, rental income tax, property management fees, utilities, and cleaning fees.
Positive cash flow happens when rental income is higher than rental property expenses. When the opposite happens, it is referred to as a negative cash flow property and is something that no real estate investor ever wants. Areas with the greatest vacation rental potential should have an abundance of positive positive cash flow properties.
To start looking for positive cash flow vacation rental properties in your city and neighborhood of choice, click here.
Capitalization rate will show you how much income is being generated in comparison to the value of the investment property. The formula is easy and straightforward:
Cap rate = Annual net operating income (NOI)/Vacation rental price
The net operating income is the difference between the gross rental income and the operating expenses (taxes, insurance, maintenance costs, etc.).
Most real estate experts are in consensus that a good cap rate for vacation rental properties should range between 8% and 12%.
Cash on cash return
Cash on cash return will show you the percentage of profit you can anticipate based on the amount of cash you’ve invested when buying a vacation rental property. Here is the formula:
Cash on cash return = Annual pre-tax cash flow/Total cash invested
The CoC return on vacation rental properties will vary depending on factors such as the income property type, the location of the investment property, and more. But generally, experts agree that a favorable cash on cash return would be anything between 8% and 12%, or more.
Another way of analyzing profitability before buying a vacation rental property is by checking the rent-to-value ratio. This ratio weighs the annual vacation rental income you can make against the overall value of the property. For instance, if you generate $50,000 from a property valued at $1,000,000, the vacation rental has a rent-to-value ratio of 5%. The rent-to-value ratio for short-term rentals varies widely, with the majority falling between 3% and 10%. Ideally, you should buy a rental property that has a rent-to-value ratio of 5% or more.
Conducting vacation rental market analysis as well as investment property analysis manually can be very time-consuming and frustrating. The good news is that you can use Mashvisor’s vacation rental property calculator to assess the vacation rental potential of any property that you consider buying. This tool will provide you with a detailed report containing all the vital metrics that will help you assess the profitability of each vacation rental property. The metrics for measuring a vacation rental’s potential provided by the Mashvisor rental property calculator include:
The unique thing about the vacation rental property calculator is that it not only estimates a vacation rental’s potential. If you ever decide to convert your vacation rental into a long-term rental, you can use the calculator to conduct all the necessary analysis. Sign up for Mashvisor now to start analyzing rental properties quickly and easily.