How to Evaluate Rental Property: Top Metrics You Should Know

Thinking about investing in a vacation rental property to rent it out on Airbnb? It can be a lucrative business decision, but it’s crucial to understand how to evaluate a rental property and estimate the potential of your vacation rental investment. After all, buying an Airbnb property is a significant financial decision, and you need to be wise to be successful.

Read on to determine how to evaluate vacation rental property to inform your buying decision. We’ll also talk about evaluating ROI on a rental property and determining whether the rental is worth the investment. Performing some simple calculations can help you choose the property that will yield the highest ROI.

Things to Consider to Evaluate Vacation Rental Property Before You Invest

It takes time and due diligence to find the perfect rental, but you should look at the bigger picture before you start calculating numbers. Learn more about the area where you are considering buying a vacation rental property to find out where it has any vacation rental demand. Consider the overall traffic and popularity of the location and determine whether it attracts travelers all the year-round or whether there is seasonality. 

Decide what type of property you want to buy and research available properties in your price range. Do market research to determine the kind of travelers the property will attract and how to compete in the area. You should browse through similar properties on Airbnb, review their prices per night, and look at how they are furnished and what amenities they offer.

You need to check local laws and regulations on short-term rental investment. Some local rules may impact the kind of properties you can invest in, while others require obtaining special short-term rental licenses or permits before getting started.

You should also be prepared for the inevitable expenses of owning, managing, and maintaining the short-term rental property. Consider ongoing property taxes, insurance payments, and maintenance costs, such as repairs, replacing broken appliances, electrician or plumber service calls, pest control, etc.

And don’t forget about property management. After all, running an Airbnb involves a lot of work and requires hosts to wear many hats. To keep your business running, you’ll need to perform such tasks as communicating with guests, arranging cleaning and maintenance, updating prices and availability, managing reviews, check-ins, and check-outs, etc.

You may want to hire a property manager to take care of these responsibilities, but you should keep in mind their services can be quite costly. Still, saving on property management costs is possible if you choose to self-manage your rental and automate routine tasks using vacation rental software like Hospitable. Our tool will allow you to automate routine tasks and save on property management fees.

How to Evaluate Rental Property Performance

One of the most important skills for vacation rental investors is understanding how to evaluate rental property performance. Fortunately, it’s not rocket science, and it doesn’t have to be difficult because it’s actually doing simple math.

Here are some tried and true real estate metrics you need to know and use while evaluating the rental property you are considering buying. And if you are comparing several rental properties, the property with the best results will be the winner.

You’ll need an analytics tool to estimate these metrics. Mashvisor and AirDNA are probably the best to start with.

Occupancy rate

There is no guarantee that you’ll generate profit if you just list your vacation home on Airbnb, Vrbo, and Booking.com. You can only make money on vacation rental property if you get bookings and maintain a good occupancy rate.

The occupancy rate is calculated by dividing the number of nights a vacation rental is booked by the number of nights it was available for rent. The occupancy rate depends a lot on the location of the vacation rental property. Also, things like the property’s size, number of bedrooms, and provided amenities can potentially help increase its occupancy rate.

Cash flow

Cash flow is the monthly profit from the rental property. You can calculate this metric by subtracting your monthly rental expenses from your monthly income. Monthly operating expenses include property tax, mortgage payments, insurance, HOA fees, rental income tax, maintenance costs, cleaning fees, and utilities.

When rental income is higher than expenses, it’s a positive cash flow. But when the opposite happens, it is referred to as a negative cash flow, which shows that the property is likely not performing as it should be and it’s not what you want.

Capitalization rate

The cap rate gives you the returns on a vacation rental property without factoring in its financing. This metric is helpful when you pay cash, and it is a good way to compare different properties you can potentially buy against one another.

You can calculate it by dividing the annual net operating income (NOI) by the vacation rental price. The NOI is the difference between the gross rental income and the operating expenses. In general, a good cap rate for vacation rental properties should range between 8% and 12%. 

Cash on cash return

The cash-on-cash return allows you to estimate the percentage of profit you can anticipate based on the amount of cash you put into the investment. Calculating this number is important in rental property analysis because it allows you to compare returns on different properties worth different amounts. You can find this number if you take the property’s annual cash flow and divide it by the total cash you invest.

The cash-on-cash return on vacation rental properties varies depending on the property type, location, and more. Most experts agree that cash-on-cash returns should be anything between 8% and 12% or more.

How to Evaluate ROI on Rental Property

People usually buy vacation rental properties to make money through rental income. That’s why measuring return on investment (ROI) is vital to determine a property’s profitability. Keep in mind that you should know this number before purchasing a vacation rental because it allows you to assess whether putting money into it is a wise choice.

Calculating a meaningful ROI for a rental property can be challenging because certain variables that come into play with real estate can be included or excluded when you do calculations. That can affect ROI numbers. It can become even more difficult if you have the option to pay in cash or take out a mortgage on a property.

If you buy a rental property with cash, calculating its ROI is fairly straightforward. Take your net operating income or net gain and divide it by the original cost. And if you take out a mortgage, you must factor in your downpayment and mortgage payment. Other variables can affect your ROI, including repairs and maintenance costs and your regular expenses.

The ROI for a vacation rental property can vary greatly, depending on whether you finance it via a mortgage or pay it in cash. As a rule of thumb, the less cash you pay upfront as a downpayment, the larger the mortgage loan balance, but the higher your ROI since your initial costs will be lower. In other words, financing allows you to increase your ROI in the short term. Besides, you can use the money you earn from renting it to help pay the mortgage.

How much you can earn depends on many factors, like your rental location, amenities, target guests, and more. But the most critical aspect of hosting that greatly impacts your bottom line is providing a great experience to your guests and making them feel they are cared for. That means you need to ensure perfect communication with your guests and be ready to answer their questions as quickly as possible.

It’s almost impossible to be available to your guests 24/7, but things get easier if you rely on software like Hospitable. Our tool uses AI to recognize questions on more than 20 common topics and can instantly craft a personalized response. Your guests will be happy, and you’ll have more time to focus on business growth.

Final Thought

Owning a vacation rental property is a great way to earn passive income. But before you get started, it’s essential to know what you’re getting into and take the time to analyze a property’s performance. And although all this evaluation may seem tedious, don’t make the mistake of buying a rental only because it seems like a good deal.

Hopefully, our guide on how to evaluate rental property will help you estimate the vacation rental potential and ensure you make an informed decision. Remember that you must evaluate a potential purchase to pick the right property to generate enough income. Then you need to take steps to make your investment work to your advantage. List your rental on popular OTA platforms, market it to attract more guests, and manage it well to succeed as a host and as an investor.

You may also want to check out our list of the best cities for Airbnb investment in Europe and the USA.