What Is Cap Rate and How Does It Apply to Short-Term Rentals?

Summary

What is cap rate?

Cap rate (capitalization rate) measures the return on a real estate investment based on its net operating income (NOI) and current market value. Simply put, it shows how profitable a property is relative to its price.

Why it matters

Think of it as a quick check on a property’s profitability—showing how much return you’re getting compared to its price. A low cap rate might mean stable, predictable income, while a higher cap rate can signal bigger potential rewards but with added risk. 

Who should know it

Real estate investors, property managers, and anyone analyzing rental properties to make smarter buying or selling decisions.

Where you’ll see it

Cap rates are commonly found in real estate listings, investment reports, and market analyses. Within AirDNA, you’ll see cap rates on individual property-for-sale pages and in our financial calculator, designed to help you compare opportunities and estimate potential returns.

Cap Rate Overview

Cap rate, or capitalization rate, is a simple way to measure how profitable a property could be compared to its price. It is usually expressed as a percentage and typically ranges between 2% and 10% for most Airbnb properties.

Why Is Cap Rate Important?

Here’s why cap rate matters for STR investors:

• Compare investments: Cap rates make it easy to compare multiple STR opportunities side by side to find the property with the best returns.
• Evaluate risk vs. reward: A high cap rate might mean higher returns but could also come with more risks, like inconsistent occupancy. A lower cap rate often signals steadier, safer income but a lower return.
• Understand payback timeline: Cap rates give you a rough idea of how long it could take to recover your initial investment. For example, a property with a 10% cap rate could pay for itself in 10 years.
• Spot profitability issues: If you already own a property, tracking cap rates can help you identify underperformance—whether it’s low income or rising costs—and figure out where improvements are needed.

How Do You Calculate the Cap Rate?

To calculate the cap rate for a short-term rental property, use the following formula:

Cap Rate = (Net Operating Income (NOI) / Purchase Price or Current Market Value) x 100

Let's break this down into clear steps:

1. Estimate annual gross rental income: Find the total income you expect to earn from bookings in a year.
2. Subtract annual operating expenses: Deduct all the costs of running the property, including:

• Cleaning and maintenance fees
• Property management fees
• Utilities (electricity, water, internet)
• Insurance and property taxes

1. Do the math: Divide the NOI (gross rental income minus expenses) by the property’s current market value or purchase price. Then, multiply the result by 100 to express it as a percentage.

If you’re looking for an easier way to estimate your short-term rental income, try our Airbnb Calculator to get an estimate of your earnings and cap rate. 

Example: Let’s say you’re evaluating a short-term rental property with these numbers:

• Annual gross rental income: $80,000
• Annual operating expenses: $25,000
• Current market value: $700,000

To calculate the NOI, your calculation would be: 80,000−25,000 = 55,000

Then to get the cap rate: (55,000 / 700,000) x 100 = 7.86% cap rate

Knowing the cap rate helps you measure a property’s profitability, but having the right financing in place is just as important. Take a look at our step-by-step guide on how to finance your vacation rental to get started.

Factors That Influence Cap Rates in Short-Term Rentals

Several key factors can affect cap rates for short-term rentals (STRs):

• Location: Prime tourist spots tend to have lower cap rates because of high property values while emerging markets often offer higher cap rates due to lower costs and growing demand.
• Occupancy rates: Seasonal demand and market shifts can impact rental income and Net Operating Income (NOI), directly influencing cap rates.
• Operating costs: STRs come with higher expenses, like cleaning fees, property management costs, and utilities, which can reduce overall profitability.
  
  Check out our full guide on how to manage short-term rental expenses.
• Market competition: More competition in your area can lower occupancy rates. This makes it harder to maintain a consistent income.
  
  Get updated market insights to help you grow your short-term rental business with our Monthly Market Review.
• Economic trends: Changes in travel habits, local regulations, or economic downturns can affect demand, income, and cap rates for short-term rentals.

Factors like location, occupancy rates, and expenses can really impact how a property performs. If you’re looking to understand its value better, check out our guide on how to value a rental property.

What Is a Good Cap Rate for Short-Term Rentals?

A good cap rate for short-term rentals (STRs) typically falls between 4% and 10%, but this can vary depending on location, market demand, operating costs, and investment strategy.

For example, a mountain cabin may have a higher cap rate due to lower costs and seasonal demand, while a city luxury condo might show a lower cap rate but provide steady year-round income.

Get more insights on what a good cap rate is in our detailed blog.

To figure out what’s good for your STR property:

• Compare with local benchmarks: Check cap rates for similar properties in your area.
• Factor in market conditions: Consider how seasonality, competition, and occupancy trends affect your income.
• Balance risk and return: A higher cap rate can mean bigger returns but more volatility. A lower cap rate often signals stability with lower risk.
• Align with your goals: If you want consistent, reliable income, aim for a lower cap rate. If you’re open to more risk for higher rewards, a higher cap rate might be the right choice.

Cap rates are a great way to measure profitability, but there’s more to consider when analyzing a market. See how we break it all down in our full guide to market analysis.