It may seem strange to some, but post-pandemic is an excellent time to pursue an Airbnb investment. There are a couple of reasons for this. First, interest rates are at their lowest, making property ownership more attainable for more people across more geographies.
Second, Americans’ travel habits have changed. With fewer travelers willing or able to board flights, Americans chose and will likely continue to opt for drive-to destinations (think: mountain towns, lakeside retreats, and beach houses) for the foreseeable future — and the data proves this. In 2020, urban and suburban rentals were down 56.4% and 39.7%, respectively.
Conversely, demand for properties in rural areas and mountain towns grew by 4.8% and 4.4% year-over-year, respectively. This means that the democratization of lodging has reached deeper into more remote destinations and smaller communities, providing the opportunity to earn income when other economic endeavors may not be readily available. Many destination markets are now among the best places for an Airbnb investment.
But before taking the plunge into Airbnb investing in any market, you have to explore the metrics that make it worth your time, energy, and resources. Knowing the cap rate, especially, is key to plotting a profitable path.
What is a Cap Rate in Regards to Airbnb Investment Opportunities?
Whether it’s an Airbnb investment, a Vrbo short-term rental, or commercial property, the same principle applies: cap rate (or, capitalization rate) remains a top metric by which to measure a real estate investment property’s profitability and return potential independent of that property’s financing method.
In short, the capitalization rate is the Net Operating Income (NOI) divided by the property asset value multiplied by 100 to achieve a percentage.
How Do You Calculate Cap Rate?
To get a clearer idea of your potential property, follow the cap rate calculation formula:
Capitalization Rate = Net Operating Income / Property Asset Value X 100
This formula is right for you (and most real estate investors) if you assume that your NOI is the expected annual income from your short-term rental once you’ve accounted for all property management expenses. Be sure to include any taxes and other costs outside of just property management fees.
Also, remember that financing costs like debt services and your mortgage aren’t included in the formula. If you’re unsure of the exact cost of your future property, just sub the property asset value for your expected purchase price to get a broader estimate.
Cap Rate Example
If you purchase a property for $1,000,000 and your annual NOI is $100,000, your cap rate comes in at 10%: $100,000 / $1,000,000 = 10. Or, 10%.
Another way to calculate cap rate is by swapping the property asset value for purchase price:
Capitalization Rate = NOI / Purchase Price X 100
While some investors do use this formula, it has a few flaws. Because you’d in this case use older properties’ prices, you’re relying on prices that are too far in the past to give you an accurate estimate.
These prices will in almost all cases be significantly lower than current values and not present an accurate representation of your earning potential. It becomes even more problematic if you’ve inherited a property, which completely throws off the formula.
Whichever formula you use, remember that while the cap rate is great for getting a better understanding of your property’s earning potential, it should not be the only metric you use to determine that potential. It’s a good starting point, but you should also factor in future cash flows related to property upgrades, the time value of money, and other factors.
What is a Good Cap Rate for an Airbnb Investment Property?
Let’s revisit the 10% cap rate that we calculated earlier. Opinions on what constitutes a good cap rate vary as widely as the factors that go into calculating the rate but, overall, 10% is solid. Let’s look at the elements that go into determining just how solid a 10% cap rate is.
Cap Rates by City, Small Towns, and Destination Markets Vary
No two markets (let alone geographies) share the same conditions. Airbnb occupancy rates in destination markets ebb and flow depending on seasonality, while many urban markets see fewer fluctuations throughout the year. Those same destination markets also see revenue generation more dependent on specific amenities than those offered in urban and suburban listings.
Further splitting population centers’ ideal cap rates from destination and rural markets’ is the cost of property. Broadly speaking, property costs more in cities than it does in more rural and destination markets, meaning that the cap rate in population centers will likely be lower than in more sparsely populated markets.
Different Properties Influence Cap Rate
Airbnb has gained attention for many reasons over the years, but one of the booking platform’s biggest draws is that it enables hosts to offer a range of unique property types. From tiny homes to opulent mansions, yurts to condos, guests have more options than ever when it comes to booking their ideal stay.
The property type you offer your guests will greatly influence your cap rate. If you’re providing a single-family home, you may expect a lower cap rate than if you listed a multi-family unit depending on your market. Simply, more rooms generally mean more revenue potential which, of course, impacts Airbnb cap rates.
Cap Rates and Risk
No matter the market, there’s always a level of risk that comes with an Airbnb investment. A cap rate, above everything else, 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.
So, considering all the factors, what is a good cap rate? The answer is that it depends. And, depending on the source, a good cap rate hovers somewhere between 8% and 12%. But remember: this is just a range, and your percentage is not the only factor in determining whether taking on an Airbnb investment is right for you.
Go Beyond the Standard Cap Rate Calculator with Rentalizer
If it sounds like the cap rate calculation formula only reveals a small-yet-broad part of planning your Airbnb investment, that’s because it does. No standalone cap rate calculator can give you all the metrics you need to plan your investment. That’s where Rentalizer and AirDNA’s Market Comparison tool come in.
Rentalizer 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 and Rentalizer reveals your potential occupancy rate, ADR, and — most importantly — your annual revenue projection.
You can even enter your target revenue and the calculator will reveal your new cap rate, operating expenses, and net operating income so you can adjust your strategy to maximize your revenue.
How to Use the Airbnb Financial Calculator
AirDNA’s Airbnb calculator goes further still. The Financial Calculator section of Rentalizer allows you to dive deeper into your operating expenses, including property taxes, HOA fees, insurance, maintenance, and other essential factors to consider when planning your pricing strategy to meet your revenue goals.
Just click “Show Details” in the bottom right of the Financial Calculator and explore your property’s associated costs and potential revenue. Once you’ve expanded the menu, you can then pinpoint how to best position your listing to enter the market.
Explore Multiple Airbnb Rental Properties in the Market Comparison Tool
If you’re considering multiple Airbnb investment properties in different markets, plug them into the Market Comparison tool. You can get a snapshot of four markets and filter by number of bedrooms how many guests properties can accommodate, as well as get accurate data on revenue, ADR, and occupancy in these markets.
While knowing your cap rate is a good start to exploring your rental and laying the foundation for your Airbnb pricing strategy, it’s just one metric by which to gauge your short-term rental return. To truly kickstart your planning, rely on Rentalizer, and hit the ground running.
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