Understanding the return on investment (ROI) is crucial when evaluating a vacation rental opportunity. A well-calculated ROI can help you make informed decisions, identify profitable properties, and avoid financial pitfalls. In this guide, we’ll walk you through the formulas, concepts, and examples you need to calculate ROI on short-term rental properties.
Understanding ROI for Short-Term Property
In simple terms, ROI measures the profitability of an investment relative to its total cost. For vacation rentals, a solid ROI ensures that the property’s income exceeds its expenses and yields an attractive return.
Three essential calculations to know:
1. ROI Formula
ROI=(AnnualNetProfit/TotalInvestment)×100ROI = (Annual Net Profit / Total Investment) \times 100 This measures the percentage return on your initial investment.
2. Cap Rate Formula
CapRate=(NOI/PropertyPurchasePrice)×100Cap Rate = (NOI / Property Purchase Price) \times 100 The Capitalization Rate (Cap Rate) shows your return before financing and helps compare different properties.
3. Cash-on-Cash Return Formula
Cash−on−CashReturn=(AnnualCashFlow/TotalCashInvested)×100Cash-on-Cash Return = (Annual Cash Flow / Total Cash Invested) \times 100 This metric focuses on the return based on actual cash invested, factoring in down payments, closing costs, and renovations.
Identify Your Total Investment Cost
Start by calculating all the money you put into the property, including:
- Purchase price
- Down payment
- Closing costs
- Renovations and repairs
- Furnishings and amenities
- Licensing and permitting fees
Example:
- Purchase Price: $400,000
- Down Payment (20%): $80,000
- Closing Costs: $8,000
- Renovations & Furnishings: $12,000
Total Investment = $100,000
Gross Rental Profit
Estimate the total rental income you expect to generate annually.
Example:
- Average Nightly Rate: $250
- Occupancy Rate: 70%
- Nights Booked per Year: 255
Gross Rental Income = 255 \times 250 = $63,750
Total Rental Expenses
Account for all operating costs:
- Mortgage payments
- Property taxes
- Insurance
- Cleaning fees
- Property management fees
- Utilities and internet
- Maintenance and repairs
Example:
- Mortgage: $1,600/month = $19,200/year
- Taxes and Insurance: $4,000/year
- Cleaning & Management: $7,000/year
- Utilities: $3,000/year
Total Expenses = $33,200
Net Rental Revenue
Net Rental Revenue = Gross Rental Income – Total Expenses
Example: Net Rental Revenue = 63,750 – 33,200 = $30,550
Now, you can calculate:
- ROI: (30,550/100,000)×100=30.55(30,550 / 100,000) \times 100 = 30.55%
- Cap Rate: (30,550/400,000)×100=7.64(30,550 / 400,000) \times 100 = 7.64%
- Cash-on-Cash Return: (30,550/100,000)×100=30.55(30,550 / 100,000) \times 100 = 30.55%
Final Thoughts
Calculating ROI, Cap Rate, and Cash-on-Cash Return gives you a complete view of a property’s investment potential. Be sure to use conservative estimates for occupancy and expenses to create a realistic projection.
Investors who master these metrics can identify profitable vacation rental opportunities, optimize returns, and build wealth steadily in the real estate market.
True/False: Did you find this guide on calculating ROI helpful for your real estate journey?
