Capitalization rate (or cap rate for short) can help determine the profitability of your vacation rental. But the topic can seem confusing and math-intensive to new or even veteran hosts. In this step-by-step guide, we break down how to calculate cap rate, how to know if your cap rate is healthy, and what your cap rate can teach you about your business.

Airbnb Cap Rate: What is a Good Rate for a Rental Property?

What is a Good Airbnb Cap Rate and How Do You Calculate It?

Measuring cap rate is key to assessing rental property profitability.

A good cap rate for a rental property balances potential returns with investment risk.

Factors like location and property type influence what is a good cap rate for a rental property.

Airbnb investing may seem lucrative, but the proverbial gold at the end of the rainbow is only within reach when you make smart, strategic investments. What do the best short-term rental (STR) investments have in common? A strong Airbnb cap rate. 

Cap rate, or capitalization rate, is a commonly used metric to evaluate the profitability and return potential of real estate investments. Essentially, it is the ratio between the net operating income (NOI) the property generates annually and its purchase price or current market value. A good cap rate is indicative of a worthwhile investment. What defines "good," however, varies based on individual investment goals, market conditions, and property types.

Before making the plunge into Airbnb investing in any market, you’ll first want to understand what a cap rate is, what a good cap rate is for your unique Airbnb, and how to use it to forecast winning investments.

An Airbnb cap rate is a metric to evaluate the attractiveness of an investment, and can be applied to a potential STR property. It is the ratio of the property's net annual rental operating income to its purchase price.

If you own an Airbnb, cap rate is a top metric by which to measure your STR’s profitability and return potential, independent of that property’s financing method.

Because Airbnb cap rate is tied to your return on investment (ROI), you might think that high cap rates are ideal. But cap rates are also a measure of risk. Whether a high or low cap rate is better depends on your risk tolerance. A higher cap rate generally corresponds with a higher-risk investment, while a lower cap rate likely signals a less risky investment. 

Learning to calculate cap rate yourself can help you get a clearer idea of your potential ROI.

Here’s how to calculate your Airbnb cap rate in 3 steps:

1. Determine the Annual Gross Rental Income

Estimate how much revenue the property will generate in a year from bookings.

If calculating annual gross rental income sounds intimidating, fear not! AirDNA can crunch the numbers for you. In the AirDNA app, you can toggle to ‘For Sale Properties’ in the location of your choosing and see projected Revenue, Occupancy, and Daily Rate for each potential property. 

Do not include mortgage payments. In our Financial Calculator, we provide average estimates for the management fee, lodging tax, and property tax as a starting point for you and leave you to update those and fill in the rest. 	

We calculate the cap rate for you, too, but don’t take the easy way out— we highly encourage potential investors to calculate the cap rate themselves, at least initially, to make sure they have a thorough understanding of this crucial metric.

3. Divide the Net Operating Income (NOI) by the Current Market Value of the Property.

In the case of the Las Vegas property example above, the net operating income is projected to be $68,547. When you’re underwriting a new investment, the purchase price is used as the asset value. The current market value for the Austin property example is $429,950.

4. Multiply the Resulting Number by 100 to Express as a Percentage.

Keep in mind that the most accurate way to calculate the cap rate is using the property asset value. You can swap the property asset value for purchase price as we did in the Las Vegas property example.

Cap Rate (%) = (Net Operating Income / Purchase Price) * 100

What Is the Best Cap Rate on Rental Property? 

Traditionally, a cap rate between 4% to 10% is considered good for rental properties, but this varies widely depending on the location and type of property. 

STR-specific contributing factors to income and risk include:

For Airbnb properties, which can have higher gross incomes due to short-term rental rates, cap rates might be higher. However, Airbnb properties might also experience higher operating costs and vacancy rates, which affects the final cap rate. Ultimately, the average Airbnb cap rate is somewhere between 2-10%.

Keep in mind that while a 10% cap rate might be solid for some rentals, that percentage is not the only factor in determining whether taking on an Airbnb investment is right for you. A good cap rate for you depends on several different factors, like cash flow and property location.

When evaluating rental properties, a bad cap rate signals a lower return on investment. It's crucial to recognize what qualifies as an unattractive cap rate in your specific market since this varies by location and property type. 

Generally, a cap rate below 4% is often considered weak, especially in areas where properties are expensive and the potential for appreciation is lower.

Your vacation rental may be amazing, but is it better than your competition? Connect your Airbnb listing to AirDNA to see its Booking Performance Score

No matter the market, there’s always a level of risk that comes with an STR investment — and your Airbnb cap rate measures that risk. Broadly speaking, lower cap rates reveal lower risk, while higher cap rates show higher levels of risk.

However, a higher cap rate often indicates a more promising Airbnb investment; higher cap rates are associated with higher rates of return. Still, lower cap rates don’t necessarily mean that a potential property won’t be a wise investment. Your purchase price, budget, location, and even neighborhood will impact your bottom line.

Airbnb cap rate isn’t a perfect indicator of profitability. 

Excludes financing costs: Cap rate calculations assume a cash purchase, thus mortgage expenses affect your actual return.

Misses capital expenditures: Cap rate focuses on net operating income, which doesn't include future large expenses.

Market variances: The desirability of a cap rate varies significantly by location, making it less reliable for comparing across different markets.

Your decision-making process should involve considering these limitations. Since the cap rate doesn't provide a comprehensive analysis, you may want to look at other metrics, such as the cash-on-cash return, to complement your understanding of an investment's potential.

Airbnb cap rates vary from market to market, which can make them difficult to calculate, especially for those with larger portfolios. STR data tools make it easy to stay on top of cap rates no matter which markets you’re considering investing in or how many properties you’d like to acquire. 

The calculation used for obtaining your cash on cash return on an investment where you did not need to take out a loan is the same as the calculation used for cap rate. The primary difference between cap rate and cash on cash returns is that the cash on cash return allows you to factor in a mortgage rate, if applicable. 

We’ve put together the top 5 cities with the highest Airbnb cap rates and mortgage-free cash-on-cash returns in various markets in 2024. Check out our article, What is a Good Cash-on-Cash Return for a Vacation Rental Property?, for a more comprehensive list of well-performing cities.

Small Cities and Rural Destinations with Highest Cap Rates

Mountain/Coastal Cities with Highest Cap Rates

Go Beyond the Standard Cap Rate Calculator 

Although cap rates may sound like a silver bullet, they’re only a small piece of the Airbnb investment puzzle. Whether you decide that a high or low cap rate is ideal for your market, you’ll still need to account for other factors, like future cash flow, to understand what return you can realistically expect. All of these variables can be difficult to fold into a single equation. Tools like AirDNA can help.

AirDNA provides the most accurate property data available, giving you clear insight into just how much your potential property can earn. No matter your market, simply enter your address to reveal your new cap rate, potential occupancy rate, ADR, and your annual revenue projection.

But drilling down on your cap rate is just the beginning. Start optimizing your pricing strategy, comparing markets, or researching comps—all of which you can do with AirDNA. Create a free account to start taking advantage of millions of data points from over 80,000 cities and neighborhoods.

What is the capitalization rate and how is it tied to your money-earning potential? We've got everything you need to know.

Airbnb Cap Rate: What is a Good Rate for a Rental Property?

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