How to Estimate Profit on a STR Property with a Rental Profit Calculator

Before investing in short-term rentals (STRs), it’s crucial to crunch the numbers using a rental profit calculator. This tool helps determine if your investment will be profitable. When done right, STRs can yield a cash-on-cash return usually higher than any other real estate investment.

But what exactly is cash-on-cash return, and why is it important? This article breaks down this metric and others in detail.

After reading this article, you’ll understand key metrics and how to use them correctly to estimate a property’s market value and potential profitability, with a focus on short-term rentals and Market Insights from iGMS.

What is a Rental Property Calculator?

A rental property calculator estimates a property’s profitability based on input data. These online tools calculate metrics like cash flow, return on investment (ROI), cap rate, and net operating income (NOI). By entering details such as property price, rental income, operating expenses, and mortgage terms, you’ll get a clear picture of potential profits.

However, these calculators can be confusing if you’re unsure how to interpret the results. Let’s dive into the key metrics and learn which ones matter most for short-term rental property investments.

Short-Term Rental Property Investing: How to Calculate ROI?

To calculate ROI, you’ll need to factor in the purchase price, loan and mortgage details (if applicable), and operational expenses, then subtract these from your revenue. Sounds simple, right?

In reality, real estate involves numerous metrics that interpret the rental property from a different perspective.

Think of metrics as lenses on your glasses, each providing a different view of market reality. Some offer a close-up view from various angles, while others provide a broader perspective. Usually, you’ll need to combine several metrics to get the full financial picture.

Keep in mind that while rental profit calculators may use similar metrics for different property types, there are key differences between vacation rentals, long-term rentals, and commercial properties. Short-term rentals on platforms like Airbnb often generate higher revenue but come with greater expenses, market volatility, and the need for hands-on, day-to-day management.

Let’s break it all down.

Calculating the Revenue

Let’s consider a hypothetical investor and host named Jane. She bought a two-bedroom condo near ski slopes. During winter, it’s almost fully booked at $400 per night. Even in the slowest season, she maintains an average occupancy of 55-60% at a lower rate of $200-250 per night.

In this scenario, Jane needs to understand both her monthly cash flow and overall annual revenue. Calculating annual income from rent is straightforward for residential properties. Simply multiply the monthly rent by 12.

Cost and Expenses

The costs of running a rental business are called operational costs. For vacation rentals, the rental property calculator must include:

• Commissions to online travel agencies (OTAs) like Airbnb and Vrbo
• Utility costs and HOA fees
• Cleaning and maintenance
• Property management fees
• Property tax

Purchase Price and Upfront Costs

When calculating ROI, factor in the purchase price and upfront costs such as:

• Closing fees
• Renovation expenses
• Furnishing costs

In our example, let’s say Jane renovated the property and put a 20% down to raise a loan.

Monthly Expenses to Deduct

Here’s a comprehensive list of expenses to deduct from monthly revenue:

Airbnb Commission

OTAs take commissions. Airbnb typically takes 3% (or 14-16% for host-only fees), while Vrbo takes about 5%.

Monthly Morgage Payment

With a 20% down payment on the purchase price, Jane needs to ensure her net rental income covers the mortgage payments and mortgage interest while maintaining positive cash flow.

Cleaning

Jane charges a cleaning fee to guests, which increases overall revenue. She pays the cleaning crew, so it’s deducted as an expense.

Insurance

Short-term rental insurance is designed to cover your property and liability while your home is being rented out to guests. Our host Jane could also opt for umbrella coverage, which provides extra protection in extreme cases when regular insurance isn’t enough, such as a major liability claim or lawsuit.

Utilities

Deduct electricity and gas bills (that are paid by hosts).

Internet, TV, Streaming Services

Forms of entertainment to enhance guest satisfaction and positive reviews.

Property Tax

With a rental property, you’ll be obligated to pay property taxes (and income taxes afterward). You’re also eligible for tax benefits.

Maintenance Costs and Repair Costs

Set aside a monthly fund for ongoing maintenance and quick repairs.

CapEx – Capital Expenditures

Jane recently renovated the property, so she doesn’t need to worry about major capital expenditures right now. CapEx is typically recorded on the balance sheet as an investment rather than an expense on the income statement.

Property Management

If Jane hires a property manager or management company, they typically charge between 10% and 40% of revenue. This would significantly impact profit calculations if she’s not handling the work herself.

What are the Most Important Metrics to Consider?

While seasoned real estate professionals use dozens of metrics, don’t let that overwhelm you. Some parameters are more crucial than others. This doesn’t mean the rest are useless – they all show the financial circumstances from different angles. However, it helps to simplify the process and focus on a few key indicators, so that rental property owners can clearly understand expected profitability.

Moreover, when dealing with short-term rental investments, you don’t want to focus on metrics that are more relevant for commercial properties, for example.

For STRs, pay close attention to these two benchmarks:

Monthly Cash Flow

Monthly cash flow is calculated by subtracting all operating expenses from the gross monthly income. Gross rental income is the average nightly rate multiplied by the number of nights rented. What’s left over after expenses is your net income.

If you have a mortgage, subtract that payment too. The formula looks like this:

Monthly Cash Flow = Rental Income − Total Expenses

Total expenses include everything: operating expenses, mortgage payment, and CapEx (but we don’t include income taxes, so it’s usually pre-tax cash flow). Ensure that after all is said and done and deducted from your total income, you maintain a positive cash flow.

Positive cash flow indicates financial health, and estimating it for slow seasons can warn you of possible shortfalls. You can calculate cash flow on a monthly basis and annually.

Cash on Cash Return

This rate of return calculates cash income earned on the cash invested in a property.

Cash-on-Cash Return = (Annual Cash Flow / Total Cash Invested) x 100

Let’s revisit our example with Jane. She invested $70,000 in the property (down payment, closing costs, renovation, and furnishing) for a $300,000 condo.

Here are her income numbers:

Occupancy Rate: 18 nights per month

Average Nightly Rate: $202.78

Gross Rental Income: $3,650 per month

Average Monthly Cash Flow: $1,250

Annual Cash Flow: $1,250 x 12 = $15,000

Cash-on-Cash Return = ($15,000 / $70,000) x 100 = 21.4%

In this case, Jane’s cash-on-cash return would be around 21.4%.

Other Real Estate Metrics

In addition to the key metrics we’ve discussed, a rental property calculator can provide several other useful indicators. Let’s break them down:

Net Operating Income (NOI)

Similar to cash flow, net income is what’s left over when recurring operating expenses are deducted from annual revenue. The key difference is that NOI doesn’t subtract mortgage payments.

Annual Net Operating Income = Annual Income – Annual Operating Expenses

While NOI doesn’t give a complete picture (as it excludes a monthly mortgage payment and CapEx), it’s crucial for calculating the cap rate.

Cap Rate

The capitalization rate, or cap rate, represents the rate of return based on the expected rental property income. To calculate, divide NOI by the current, possibly appreciated home value:

Cap Rate = (Net Operating Income / Current Property Value) x 100

A higher cap rate suggests a potentially greater return on an investment property but may also imply higher risk or a less desirable location.

IRR (Internal Rate of Return)

IRR helps investors understand the yearly return they’re getting over the lifetime of a long-term investment. IRR is especially important when cash flows are spread out over many years, like in real estate.

Definition: The Internal Rate of Return (“IRR”) is the rate (“r”) at which the Net Present Value (“NPV”) of all future cash inflows and outflows (“CF”) for a project is zero.

0 = CF₀ + CF₁/(1+IRR)¹ + CF₂/(1+IRR)² + … + CFₙ/(1+IRR)ⁿ

While the formula itself seems a bit of a head-scratcher, IRR is a crucial metric because it shows how your investment performs annually (year 1, year 2, year 3 and on until you decide to sell it at an appreciated price). It helps you plan the target income for each year.

When you have debt on the property, the advice is to look for a higher IRR of between 7-20% for a five to 10-year investment period. Without debt, IRR can be lower.

Annual Return

Annual return measures a property investment’s profitability over a one-year period:

Annual Return = (Appreciated Home Value – Purchase Price) + Net Operating Income (NOI)

This metric provides insight into the overall profitability of your real estate investments, including rental property appreciation.

Home Equity

Home equity is the portion of the property you own outright (based on the mortgage you’ve already paid off):

Home Equity = Current Market Value of the Property – Remaining Mortgage Balance

Gross Annual Yield

Typically calculated annually, gross yield provides a snapshot of the property’s revenue potential before deducting expenses:

Gross Yield = (Gross Rental Income / Appreciated Property Value) x 100

This formula helps investors evaluate a short-term rental property’s income potential relative to its cost.

Why is Cash on Cash Return Considered the Most Important Metric for Rental Properties and What is a Good Figure?

In the world of real estate investing it’s rare to find someone who buys rental properties with a lump sum upfront. Instead, they typically use a combination of a down payment and a loan at an interest rate. This approach is common because it allows investors to work on multiple investments simultaneously and set them up for profit in a shorter timeframe. Investors often partner with private money lenders or raise a bank loan.

That’s why cash-on-cash return is considered the straightforward metric to demonstrate profitability. It directly shows how much cash the investment is generating compared to the actual cash invested.

According to AirDNA, a good cash-on-cash return starts at 10%. However, many investors set their benchmark higher, aiming for 15-20%. Of course, several factors can influence what’s considered a “good” return:

1. Location
2. Seasonality
3. Amenities: Features like hot tubs or pickleball courts can elevate prices and potential returns.
4. Overall economic climate and local trends.

Does Cap Rate Matter for STR?

Cap rate doesn’t take into consideration your loan, so it’s not the best metric to gauge your return on investment when having mortgage payments or partnering with money lenders. On the other hand, the capitalization rate has great significance for commercial properties, where income primarily determines property value.

Still, it can provide a starting point for financial analysis and income-generating potential relative to the value in a given market.

A Good Return on Investment: What Are the 1% and 2% Rules for Rental Properties?

All the metrics mentioned above estimate your rental ROI. However, you can also apply a simplified formula:

ROI = (Annual Net Profit – Total Investment) x 100

There’s no single answer to what makes a good ROI. It depends on the situation. In the U.S., residential properties generate an average annual return of 10.6%, while REITs average 11.8%, according to the S&P 500. It’s quite safe to say that anything above 10% is a good return.

To better gauge profitability, consider the 1% rule. It suggests that a rental property’s monthly income should be at least 1% of its purchase price. In our hypothetical example, Jane bought a property for $300.000, so her average monthly income should be at least $3.000.

Likewise, the 2% rule suggests that the monthly rental income should ideally meet or exceed 2% of the property’s purchase price. For instance, applying this guideline to a $300,000 rental property would mean aiming for a monthly rental income of at least $ 6.000.

Of course, don’t take this rule word for word. Consider it more as a general orientation rather than a rule.

Property Value Appreciation Increases Your ROI

Return on your rental property investment occurs in two ways: through rental profit and property appreciation.

Property appreciation refers to the increase in your property value over time. The current market value typically rises, especially after renovations have been completed. This appreciation gives you leverage for future refinancing and reinvesting.

Wrapping up

Before making investment decisions, use a rental income calculator to ensure positive cash flow and a good return on investment (ROI). When using the calculator, always input higher expenses to give yourself a safety cushion and increase your risk tolerance. This way, if costs end up being higher than estimated, you won’t fall short in your calculations.

The next level of running your rental business is automating daily tasks with property management software, such as iGMS.