Calculating ROI for your Vacation Rental Property

Calculating ROI for your Vacation Rental Property

What is ROI?

So you’re considering buying a vacation rental property – congratulations! That’s a big decision. The big question now is: is the home you’re considering buying a good investment?

One of the most important steps when considering whether or not to invest in a specific rental home is to calculate your projected ROI to give you a better idea if that home is a smart investment or a not-so-smart one.

Here’s what you should know about calculating ROI on a vacation rental investment property:

Let’s start with the basics. What is ROI? ROI stands for ‘return on investment’, and is a way of measuring how much profit you’ll make on your investment (which in this case is a vacation rental property).

The process for calculating return on investment for a vacation rental can be finicky. This is because the final number can be manipulated by including or excluding certain expenses as well as by over- or under-estimating your expected rental income. 

We should also note here that the calculation will vary depending on whether you are financing your purchase or paying cash, we’ll cover this more later on in this post.

The numbers

Before you can do any actual calculations, you need to gather the right numbers. 

Let’s start with your expenses. In addition to your recurring expenses, like utilities or property taxes or WiFi, you’ll need to include any up-front expenses incurred in the purchase process. Things like closing costs, down payment (if you’re financing the home), repairs or renovations, and interest rate.

Warning: You might be tempted to fudge the numbers a little here to tilt the scales in your favor. Our advice? Tell the devil on your shoulder to take a hike, the important thing here is getting an accurate number – not making yourself look good on paper. This means doing your homework to find out exactly how much your property will cost you in property tax, HOA fees, insurance, etc.

Once you have your expenses nailed down, it’s time to figure out how much income you can expect your home to bring in. Check out our previous article, How much money can you make from a vacation rental to learn more about how to do this.

Now that you’ve gathered your numbers, you’re ready to calculate the potential ROI for your vacation rental.

Calculating ROI for cash transactions

Calculating ROI for a cash purchase is fairly straightforward. The formula looks like this:

Net Profit (annual rental income – annual expenses) / Cost of Investment = ROI

To show you how this works, let’s look at an example scenario of a vacation rental purchased for $250,000 cash:

  • Asking price: $500,000
  • Closing Costs: $6,000
  • Up-front repairs & renovations: $15,000
  • Rental income: $2,800/month or $33,600/year
  • Recurring expenses (home insurance, HOA, utilities, etc.): $400/month or $4,800/year

Plugging the above numbers into our equation, we can calculate the ROI:

  • Net Profit: $33,600 – $4,800 = $28,800
  • Cost of Investment: $500,000 + $6,000 + $15,000 = $521,000

ROI = $28,800/$521,000

ROI = .055 or 5.5%

Calculating ROI for financed properties

The calculation is similar for financed investments, with just a couple of adjustments made to the total cost of investment and recurring expenses.

Here’s an example for the same $500,000 property, this time taking mortgage payments into consideration:

  • Asking price: $500,000
  • Down Payment: 20% or $100,000
  • Closing Costs: $6,000
  • Up-front repairs & renovations: $15,000
  • Rental Income: $2,800/month or $33,600/year
  • Recurring expenses (home insurance, HOA, utilities, etc.): $400/month or $4,800/year
  • Mortgage Interest Rate: 3.5%
  • Mortgage Payment: $1,796/month or $21,552/year

Let’s look at how these numbers work out in our ROI calculation:

  • Net Profit: $33,600 – $4,800 – $21,552 = $7,248
  • Cost of Investment: $100,000 + $6,000 + $15,000 = $121,000

ROI = $7,248/$121,000

ROI = .059 or 5.9%

Is X% a good ROI for a vacation rental home?

The truth is, there isn’t an exact number a rental property has to hit to be considered a ‘good’ investment, especially when you take into consideration other factors like location, access for personal use of the home, or market fluctuation.

Vacation Rental ROI Calculators

Need some help calculating ROI for your vacation rental property? Try one of these online calculators: