What is Cap Rate?
Cap rate represents the expected rate of return on a property based on its net operating income (NOI). For busy vacation rental managers, it offers a convenient snapshot that allows you to:
- Compare opportunities quickly: Evaluate different properties side by side.
- Assess risk vs. return: A higher cap rate often means higher potential returns but also higher risk.
Essentially, the cap rate helps you weigh one investment opportunity against another, especially when juggling multiple properties in growing vacation rental markets.
How to calculate cap rate in short term rentals?
Formula:
Cap Rate = Net Operating Income (NOI) / Current Market Value
- Net Operating Income (NOI): Sum up all your gross rental revenue, then subtract operating expenses like utilities, maintenance, insurance, and property taxes.
- Current Market Value: Use the property’s present fair market price.
Why exclude mortgage payments?
Mortgage payments aren’t factored into NOI. This approach focuses on the property’s direct potential to generate income, giving you a clear picture of its standalone performance.
Use as preset calculator to work out the cap rate on your property.
What’s a Good Cap Rate?
Typically, a “good” cap rate sits somewhere in the 4–10% range. The sweet spot varies based on personal risk tolerance, financing options, and the specifics of your market.
- Higher cap rate: Suggests greater returns, but comes with higher risks (like market volatility or less stable rental demand).
- Lower cap rate: Implies more security, but also lower returns.
Influencing Factors:
- Location & Market Trends: Local regulations, tourism seasonality, and economic conditions all affect rental demand and property value.
- Future Growth Potential: If you anticipate rising rental rates or property values, a slightly lower cap rate may still be attractive.
- Available Capital: Your liquidity and financing options can impact how much risk you’re willing to take on.
Putting Cap Rate to Work
A well-calculated cap rate can serve as a powerful lens, helping you decide which properties to invest in or expand.
It’s a tool that keeps you client-focused and forward-thinking, aligning with a holistic vacation rental strategy that not only drives revenue but also sustains long-term growth.
By examining NOI, market value, and your unique risk profile, you’ll be prepared to make informed, confident decisions as you scale your vacation rental portfolio.
