How To Calculate ROI On A Short-Term Rental

How To Calculate ROI On A Short-Term Rental

Short-term rentals have become an increasingly significant source of income for people who own properties. Instead of hotels, people are now heading to sites like Airbnb and Booking.com to find a more home-like place to stay when they go on vacations and business trips. Due to this, more people are looking at investing in properties and transforming them into quality short-term rentals. 

But once you’ve made the investment and started your short-term rental business, how can you figure out how much profit you’re actually making? Luckily, there are easy calculations you can use that show you your return on investment.

What is ROI?

ROI stands for Return on Investment, and it is a measure of how much profit you’ve made on an investment. It considers the cost of your investment and shows how it provides you with money in return. By calculating the ROI, investors can tell if it is worth making an investment and whether they should continue with it. 

While ROI can be used to calculate the profits on any investment, they are particularly helpful with short-term rentals. However, calculating your ROI may be difficult without the right equation, and sometimes there are certain variables to include, such as how you paid for the property in the first place. 

Why is ROI important?

When you make an investment, you’re not going in blind. If you were, it would be a bad business choice. So instead, you want to ensure that your investment provides you with the expected gains.

While calculating the ROI of a property before you purchase it may not be completely accurate because you don’t know exactly how much you’ll be spending and making, it can give you a rough idea. It is useful to estimate your expenses and determine the average income that people with similar short-term rental properties make. Use these figures to predict what your ROI could be.

It’s also important to continue to calculate your ROI every year or so after you’ve made the investment. It will provide insights into whether your investment is working and whether you should continue with it or make any changes. 

The ROI formula for short-term rentals

While there are often a few variables to consider depending on how you invested in your short-term rental property. However, a general ROI formula can be used as a basis before adding any separate variables. 

If you want to figure out how much profit you’ve made on your short-term rental investment, you’ll need to take your total return on investment and take away the original amount you put into the investment, 

If you work backward from this and want to figure out the percentage ROI of your short-term rental, you’ll need to take your net profit and divide it by how much you originally put into the investment. 

For example, if you paid $1,000,000 for your property and after all your bookings for the year made $1,200,000, then your net profit would be $200,000. 

ROI on cash payments

So, although there is a simple calculation you can use as stated above, there are several other variables with short-term rentals you’ll need to include. One of these is if you purchased the property you’re renting out to guests with cash. Therefore, you can use a special ROI calculation in this case. 

Let’s learn the calculation for this by looking at an example:

You purchased the property you’re renting out to guests for $1,000,000 in cash. However, there were additional costs you had to pay, such as the closing cost of $5,000 and renovations for $20,000. 

This means your overall investment added up to $1,025,000. 

Once guests started to stay in your short-term rental, you started to make $300 a night per booking. Let’s say someone just happened to be in your property every night of the year. That means your annual rental income would be $109,500. However, you still had to pay for bills, insurance, taxes, and maintenance fees, which added up to around $30,000. 

This means your total annual return was $79,500.

Therefore, if you want to calculate the ROI percentage, you’ll need to divide the annual return of $79,500 by the overall investment of $1,025,000. 

This gives you a rounded-up figure of 0.078, so your ROI was 7.8% for the year. 

ROI for a financed property

So, you know how to calculate your ROI on your short-term rental if you paid for the property upfront in cash, but what if you decided to take out a mortgage? That makes it a financed transaction, and therefore it is a little bit more tricky to calculate. 

But don’t worry, we’ll talk you through this process with an example as well:

Let’s use the same property as the previous example. The cost of the property was $1,000,000, but you decided to take out a mortgage that requires a downpayment instead of paying the entire amount upfront. If the mortgage needed a downpayment of 20%, then you would need to pay $200,000 upfront. Closing costs came to $7,500, and you needed to pay for renovations which were an extra $20,000. 

This came to a total of $227,500 for your initial investment. 

However, this won’t be your only investment, as you’ll still need to pay off your monthly mortgage. For example, suppose you needed to pay $3,000 monthly for your mortgage, that would add up to $36,000 for the year. However, you still had to pay for bills, insurance, taxes, and maintenance fees, which added up to around $30,000. 

This means you pay $66,000 for the property each year. 

Once guests started to stay in your short-term rental, you started to make $300 a night per booking. Let’s say someone just happened to be in your property every night of the year. That means your annual rental income would be $109,500. 

If you take the $66,000 away from this, you will have an annual return of $43,500. 

Therefore, if you want to calculate the ROI percentage, you’ll need to divide the annual return of $43,500 by the initial investment of $227,500. 

This gives you a rounded-up figure of 0.191, so your ROI was 19.1% for the year. 

Is your ROI percentage good?

So, you’ve calculated your ROI percentage on your property, but how do you know if it's good? Unfortunately, there is no simple answer for this as every short-term rental property differs depending on various factors such as its location and pricing. 

However, there is a basis you can use. If you have an ROI percentage of over 15%, then you most likely have a good return on your investment. However, as mentioned, this may not be the case for your property. If you’re unsure about your ROI, you can speak to an accountant or financial manager who can help you figure out how your investment is doing. 

The 1% rule

Before we wrap up ROI calculations, let’s take a look at the 1% rule. This is often used when people rent out properties and can also be used with short-term rentals. It helps you find the best property to invest in by figuring out how much you’d charge for rent before you even purchase it. 

Basically, the 1% rule states that your monthly rent on a property should be 1% of the total purchase value of the property. Therefore, your monthly cost for your short-term rental should add up to 1% of the property value if you have a booking every night of the month. For example, if you paid $1,000,000 for your property, your nightly cost should cost between $357 to $322 to add up to the 1% value of $10,000 for the month. 

However, although this is a rule used by many investors, it isn’t completely full-proof. Instead, it is used as a guide to help investors figure out roughly how much they’ll be charging for their short-term rental before making the purchase. They can then use this figure as a baseline to figure out a predictive ROI percentage. 

Final thoughts

Short-term rentals are a huge thing in the business world at the moment, and they can make you a large amount of money. However, you want to ensure that if you invest in this industry and find a property you want to use for guests, you’ll be able to make a suitable profit throughout the years. 

You want your investment to pay off, so calculating your ROI before and during your investment can give you some great insights into whether this will happen. Stick to these calculations regularly, and you will be able to look out for yourself and your finances.