So you’ve finally bought your dream rental property. Congratulations! While that is an extremely exciting step, there is still a lot to be done. For one, its important to understand if the property is making enough money to justify your investment. As a result, you need to ask yourself, “What is a good rate of return on a rental property?” The answer to that question depends on a variety of factors, including your property’s location, operating costs, financing, investing goals, and your overall business strategy. This blog post covers everything you need to know about a solid rate of return to help you determine if your property makes the cut.
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What is a good rate of return on rental property?
Ultimately, what is considered a good rate of return will vary by your specific property and location. Typically, many real estate investors say to aim for somewhere between 8%-12% of a cash-on-cash return, with 10%- 12% being ideal. The following is typically how certain cash-on-cash return rates are perceived by investors:
- Below 5%: This is considered a relatively low cash-on-cash return. However, it may still make sense for your business if you expect property appreciation, mortgage principal paydown, or other long-term benefits
- 5%-8%: This range is still reasonable, especially if you’re playing the long game where you’re prioritizing stability and/or long-term growth.
- 8%-12%: This is the typical range investors are looking for when elevating how profitable a property can be.
- Above 12%: If your projections are truly realistic, anything above 12% is considered highly profitable.
How to measure your rate of return
But how do you determine your rate of return? There are three main metrics you need to look at.
Cash-on-cash return
Best for: Evaluating a property’s ongoing cash flow.
Cash-on-cash return refers to how much income your short-term rental generates (pre-tax) compared to how much money you’ve invested in the property. Follow the formula below:
Cash-on-cash return = (Annual pre-tax cash flow ÷ Total cash invested) X 100
For example, if you invest $100,000 in a rental property and generate $12,000 in annual pre-tax cash flow, your cash-on-cash return is 12%.
Capitalization rate
Best for: Comparing income potential between properties before financing.
Also referred to as a “cap rate,” the capitalization rate measures a property’s annual net operating income relative to its purchase price or current market value. The formula is:
Cap rate = (Annual net operating income ÷ Property value) × 100
For example, a property valued at $400,000 that generates $30,000 in annual net operating income has a cap rate of 7.5%. A higher cap rate can indicate greater income relative to the property’s value, but it doesn’t automatically mean a better investment. Local market conditions, property condition, and potential risks also matter.
Return on investment
Best for: Analyzing the broader long-term investment over time.
Return on investment (ROI) is what it sounds like: how much a property earns based on how much one invested in it. The formula is:
ROI = (Net profit ÷ Total investment cost) × 100
If your total investment cost is $100,000 and your net profit over a defined period is $15,000, your ROI for that period is 15%. If the profit accumulates over multiple years, don’t interpret that figure as an annual return without accounting for the time involved. ROI helps you see the long-term bigger picture.
What affects your property’s rate of return?
Even two properties in the same neighborhood can have vastly different rates of return. There is a lot to consider when determining what a specific property’s rate of return might be as a short-term rental. The following are some important factors:
Location and demand
Location is huge. Is the property near a major tourist site or out in the country? One needs to research the local occupancy rates, average nightly rates, seasonal demand, and competition.
Purchase price and financing
Consider how much you’re paying for the property and how you’re financing it. Your down payment, mortgage interest rate, loan term, and closing costs all influence how much cash you need upfront and how much income remains after monthly payments. While financing can help you acquire a property without paying its full purchase price in cash, higher borrowing costs can reduce your monthly cash flow and increase your financial risk.
Operating expenses
Running a short-term rental means spending money on regular turnovers, maintenance, marketing, and a whole lot more. Consider how much you’re going to be spending to keep this short-term rental up and running in tip-top shape.
Pricing and occupancy rates
The relationship between your occupancy rates and pricing strategy is strong. Instead of focusing exclusively on occupancy, consider how much revenue each booking generates and how pricing changes throughout the year. Adjust nightly rates to reflect seasonality, local events, holidays, and booking demand to balance occupancy with profitability.
Time spent
Lastly, consider how much time you’re spending working on the property. Of course, when you integrate with Host Tools, you can automate tasks and save up to 80% of your time on daily tasks.
How to improve your rate of return
Have you found your rate of return and want to improve it? Follow the tips below to improve your numbers:
- Optimize your nightly rates: Find the right pricing (or use dynamic pricing) to make sure you aren’t pricing too high or too low. Too high and you could scare away guests, and too low might mean you’re leaving money on the table.
- Lower your operating costs: Review all of your bills and recurring costs. Look to see if there are places you can cut down.
- Improve your guest experience: Take a look at your guest reviews and see if there are any common complaints. Is your internet too slow? Make the upgrade to better internet, and you’ll see better reviews, more guests, and ultimately more income.
- Automate tasks. Let Host Tools help you automate check-in, manage your calendar, cleaning schedules, and more.
Final thoughts
So, what is a good rate of return on rental property? While many investors aim for an 8%–12% cash-on-cash return, the right benchmark ultimately depends on your investment goals, local market, and operating expenses. The key is knowing your numbers and understanding how your property’s performance measures up against your expectations.
Host Tools provides an automated, unified calendar for short-term rental hosts, allowing you to seamlessly list on all major channels. Start your free trial today!
