Every vacation rental property owner has his/her own specific goals. An owner might be looking for additional immediate income. Or accelerated repayment of a mortgage on a home that will be sold in a short window. Or it could be one more addition to a portfolio of long-term buy-and-hold properties. But whatever your goals might be, there are certain considerations to keep in mind when evaluating the profitability of a given STR property.
Considerations When Buying
When you are considering a given property, there are several important factors to consider:
- Renovation and maintenance — how much needs to be done to the property to make it STR-ready? Keep in mind that a “good enough” attitude towards renovations will affect your average nightly rate. Once those renovations are finished, what are your maintenance costs going to be? The maintenance for amenities like a pool or jacuzzi need to be accounted for.
- Insurance — do you have the proper insurance for your property, including a provision/rider for vacation rental guests?
- Seasonality — how often is this STR going to be rented? You can use that estimate together with an average nightly rate to project gross income.
- Mortgage — if you are not buying the property with cash, what’s the cost of the note?
- Management and cleaning — Are you going to have a property manager and/or cleaning company? What are those costs going to be?
Ratios to Consider
When you’ve gone through the considerations above you will have most of the information you need to start putting together pieces of the financial puzzle for a given STR listing.
NOI is net operating income. It’s your gross income minus your operating expenses.
Cash on Cash Return
You can determine this by taking your NOI and divide it by the cash used to buy the property.
Annual Gross Rent Multiplier
This is used by investors to compare rental property opportunities in a given market. It’s the ratio of the property’s market value to it’s annual gross rental income.
You can take your NOI and subtract any debt you’re holding on the property to calculate cash flow. It the number is positive, you are profitable. Otherwise the property isn’t profitable…yet.
So going back to the point we made at the beginning, these numbers are going to mean different things, depending on given investment goals. Some STR owners are happy to get anywhere between 5-10% on their listings. Others need a minimum of 10%. Still others won’t look at anything under 20%.
So, the most important way to look at “how much should a vacation rental make” is how much do you want it to make? By having clarity on your investment goals and what your operating capital is for buying and renovating a place to turn into an STR, you can avoid falling prey to the excitement of making money in vacation rental and instead focus on the cold hard facts that will help you realize if there is cold hard cash to be made.
This content originally appeared in our twice-monthly Guest Book Newsletter.