Calculating Your ROI When Buying a Vacation Rental

Published Jun 18, 2022

So you'd like to buy a beautiful cabin in the Smoky Mountains and rent it out to vacationers. That's a wise choice. The Smokies are a popular destination. But how will you know if your investment in a rental cabin here is truly paying off? Learning the basics of "return on investment" will help.

ROI, which stands for return on investment, refers to the profit you make on your investment. It is expressed as a percentage of the cost of the investment. Calculating your ROI on a rental property depends on whether you paid in cash or obtained a mortgage. Additionally, you need to factor in various costs such as closing costs, taxes, maintenance and repair costs, utilities, insurance, and other expenses associated with owning and operating a vacation rental. For a rental cabin, these costs could include Wi-Fi bills, maintenance bills for amenities like a hot tub, or fees paid to a property management company for guest bookings.

Let's walk through an example from Investopedia to understand how ROI is calculated:

The basic formula for ROI is:

(Annual rental income - expenses and costs) / Property price = ROI

In simple terms, you subtract the costs of running the cabin from the amount you made in rental income, and then divide the remaining amount by the price you paid for the cabin. This will give you your ROI. Let's consider an example:

  1. You purchase a cabin for $100,000 in cash, without a mortgage loan.
  2. You pay $1,000 in closing costs and spend an additional $9,000 on renovations. Your total investment is $110,000.
  3. Over a year, you earn $12,000 in gross rental income from the cabin.
  4. During that year, you have $2,400 in expenses for property taxes, insurance, and utilities.
  5. Subtract the expenses ($2,400) from the income ($12,000). This leaves you with $9,600 as your annual return.
  6. Divide the annual return by your total investment ($110,000), resulting in $9,600 / $110,000 = 0.087.
  7. Convert the decimal into a percentage: 0.087 * 100 = 8.7 percent. Your return on investment for the cabin that year is 8.7 percent.

To summarize the steps:

(Annual rental income - expenses and costs) / Property price = ROI

(12,000 - 2,400) / 110,000 = 0.087 or 8.7 percent ROI

Calculating your ROI when financing the cabin is more complex. Your annual return will be lower due to the interest payments on the mortgage. However, your ROI may still be higher because your initial investment is lower when considering the down payment and closing costs compared to paying in full for the property.

Determining a "good" ROI on a rental property depends on individual preferences and financial goals. Some owners may be content with a lower ROI for a property in a reliable location that consistently attracts renters. Others may set a specific ROI threshold and only consider properties that meet or exceed that rate.

Generally speaking, a good ROI for a property purchased with cash is around 15 percent. For properties bought with financing, a rate of 8 percent to 12 percent is considered good according to some financial advisers.

If you're considering becoming a cabin owner, it is advisable not to navigate the process alone. Consult cabin management experts who are knowledgeable about the market and can alleviate the challenges of running a rental cabin. Reach out to our Owner Success Team at 865-365-0240 today for assistance.

Partner with Colonial Properties Cabin & Resort Rentals