HOW DO YOU ESTIMATE VACATION RENTAL OR AIRBNB EXPENSES AND OPERATING COSTS WHEN DETERMINING CAP RATE?
A vacation home with low expenses and operating costs in a high-demand real estate market is likely to have a good cap rate. Expenses and operating costs will vary depending on various factors, including location, the type of property you buy, and the method of property management you prefer.
Take the time to figure out utilities and taxes for each property when determining your expenses in vacation rental markets. Sometimes finding a better cap rate is as simple as searching for homes in lower-tax neighborhoods that still hold appeal for guests.
If you plan to host guests on a regular basis in your vacation home, you should expect a bit of wear and tear. Factoring in things like maintenance, replacement, and repair costs, you should budget around 5%–10% of your net rental income to cover updates. You can then factor in your mortgage.
The most variable expense to consider when determining the cap rate is property management. If you plan to self-manage, you will need to account for everything from cleaning, maintenance, supplies, and marketing to guest support, accounting, and insurance. Or you can use a full-service vacation rental property manager, like Magical Vacation Homes
Working with a full-service property manager not only means someone else is doing all of this work for you, but it also consolidates all of your property management expenses so that you can more easily factor cap rate.
WHICH IS BETTER: A HIGHER CAP RATE OR A LOWER CAP RATE?
A higher number is generally better regarding the cap rate—but it’s not everything. If you’re deciding between a vacation rental property with a 6% cap rate and another with a 2% cap rate, you’ll get a higher return on investment with the 6% property. But there’s more to think about.
The cap rate doesn’t include potential equity growth or emotional value such as locking in a dream home for retirement. Sometimes a house with a slightly lower cap rate is simply a better fit for you and your family.
WHAT IS A GOOD CAP RATE FOR RENTAL PROPERTY?
What you’ll consider a good target cap rate will vary based on the market—due to differing rental demand, property types, and home prices.
DOES CAP RATE TAKE INTO ACCOUNT APPRECIATION?
Cap rate doesn’t consider the benefits of potential appreciation. As a shortcut, you can add the anticipated appreciation to your cap rate to estimate your total return. A 5% cap rate and 5% appreciation give a total return of 10%, comparing favorably to current interest rates and long-term stock market returns.
WHAT IS CASH-ON-CASH RETURN?
A related metric that considers mortgage financing is cash-on-cash return, which compares cash flows, minus financing expenses, with the down payment. Cash-on-cash returns just consider the difference between the income and the mortgage against the down payment, so they can be extremely sensitive to variations in performance.
For example:
$600,000 purchase price
$100,000 down payment
$1,800 monthly mortgage payment
