Summary: Short-term rentals are popular investments among doctors. They offer the possibility for higher cash-on-cash returns and significant tax benefits, without needing to qualify for real estate professional status. Many would-be investors, however, don’t know how to tell when a short-term rental property is a good deal. In many cases, they get caught up in analysis paralysis and fail to act, or worse, act blindly and end up with a liability rather than a cashflow machine on their hands. Learning to use and consistently analyzing deals with a cash-on-cash calculator is the key to short-term rental mastery. In this post, we cover the details of how to use our short-term rental cash-on-cash calculator to determine which short-term rentals to add to your investment real estate portfolio.
[Disclaimer: We are not accountants, lawyers or financial advisors, so please consult your own team of professionals about the topics covered in this article.]
Adding a short-term rental (or more than one!) to your investment real estate portfolio can be a boon to cashflow and to your net worth.
When purchased appropriately, short-term rentals (STRs) can provide significant cashflow as well as tax benefits. Even if you don’t have real estate professional status. Many in our Semi-Retired MD Community aim to get a cash-on-cash returns of greater than 20% with their short-term rentals.
On top of that, they harvest tax savings by meeting criteria for material participation, allowing them to generate active losses from their properties using depreciation and rehabs and even purchasing furniture. These losses shelter active income. Often resulting in tens of thousands of dollars of tax savings.
When you add higher cash-on-cash return, tax savings and forced appreciation, STR returns can contribute to significant growth in your net worth in just one year.
But there is a catch: you must buy good deals.
Using your Short-Term Rental Cash-on-Cash Calculator to Find an Asset!
If you don’t start out with a good deal, you buy a liability, not an asset. That liability can weigh on your finances. Draining you each month as you support the mortgage and cover maintenance and repairs.
Unfortunately, many doctors find themselves in the position of supporting a liability.
Sometimes it’s because they aimed for tax savings and ignored the basics of the deal. Other times it’s because they didn’t know what a good deal was. Therefore, they acted blindly. Or, they weren’t aiming to buy a cashflowing property in the first place. Instead, they purchased a second home that they believed they would use as a vacation property for themselves. However, now they don’t use it frequently, so they want to convert it into an asset instead.
So, how do you tell if a particular property is going to (or can) be an excellent cashflowing short-term rental?
Use a Short-Term Rental Cash-on-Cash Calculator
The key is consistently using a cash-on-cash calculator to “run the numbers”. This will predict how a particular property will perform even before you purchase it.
Lucky for you, we’ve created a cash-on-cash calculator you can use for free to do just that!
In this post, we’ll be diving into the details of how to use the short-term rental cash-on-cash calculator.
The goal is that by the time you finish reading this, you will know what variables to put in each field. You’ll also know how to go find accurate numbers. Which will enable you to easily predict how your short-term rental will perform even before you purchase it.
Don’t Forget the Long-Term Rental Cash-On-Cash Calculator
In addition to plugging each short-term rental opportunity into the cash-on-cash calculator before purchase, we highly recommend you also use our long-term rental cash-on-cash calculator found here to run the numbers.
If you buy a short-term rental that also works as a long-term rental, you have a back-up plan.
Being a great real estate investor involves risk-mitigation. If a property cashflows as both a long and short-term rental, you now have a way to get through tough times. For example, if there’s a downturn and vacation renters dry up. Or, if your city passes damaging short-term rental regulations, you’ll be okay.
How to Use the Short-Term Rental Cash-on-Cash Calculator
Here’s a quick look at our cash-on-cash calculator.
Notice, there is a second page on the excel sheet entitled “Instructions and Disclaimer.” This is where you can go to get details about what variables you should put into the peach-colored cells. It will remind you, for example, that closing costs generally run 1-3% of the purchase price.
Also please note that you should only change the peach-colored cells. The white cells have formulas associated with them.
If you change a white cell, you’ll find that the calculator is no longer accurate. To maintain the integrity of the calculator, we recommend downloading it and then creating a copy of original download each time you run the numbers for a new property.
We also encourage you to save each calculation you do. You’ll find that over time, you’ll want to return to previous calculations on properties you previously assessed or purchased, to compare them apples-to-apples to new potential deals.
Now, let’s dive into the details!
Section 1: Rental Income Data for your Short-Term Rental Cash-on-Cash Calculator
This section includes the average daily rate and occupancy rate as a percentage of time. In this example, your property will be rented at $350 a night, on average, 80% of the year.
When estimating the average nightly rent, you’re going to have to average out the weekday and weekend rates and consider any seasonality you may have. If you generally rent at $300 a night four days a week and $500 a night three days a week, for example, you’d average that out to get a rough daily rate. You might also have a higher rental price on holidays or during specific events (i.e. Coachella in Palm Springs). Therefore, you may want to factor that into your calculations as well. This will be a rough average.
The percentage of occupancy is based on how many days your property will be rented. Many in our community start by running occupancy around 40-60%. Even if you can get occupancy rates up to 80-90%, we as owners may not want such high occupancy because of the increased wear and tear on the property. Instead, we’d rather increase the nightly rates to keep occupancy lower. This increases the profit margin due to reduced expenses while maintaining or even increasing cashflow. High rates also increase the odds of quality tenants and potentially reduce bookings by the weekend party crews.
Gather Data on Rates
The most accurate place to get data on the average daily rate and occupancy rate is to speak to several short-term rental focused property managers. Prior to purchasing (or even putting in an offer), you should consider calling several property managers to get their input on the average daily rates. The higher the accuracy of your assumptions, the better you’re going to be predict property performance.
In addition to discussing occupancy and rate with property managers, you can run the numbers in AirDNA. This will allow you to compare the nightly rates and occupancy of similar types of properties available for rent as short-term rentals in the area.
AirDNA will also allow you to evaluate how room number affects the rate. This is especially important if there is the opportunity to tap into hidden value by adding an extra bedroom or bathroom.
Finally, we compare current available properties on AirDNA and VRBO with the property. We want to see what similar rentals are going for and the amenities offered. Be sure to check out the properties’ calendars to see how far out in advance they are booked at that price point as well. If a particular property is booked solid for the next three months, its nightly rate is likely too low.
As is the case with all the variables we’ll discuss in this post, we encourage you to run the numbers under multiple different scenarios to see at what point your cash-on-cash return works for you.
Section 2: Purchase Data for Your Short-Term Rental Cash-on-Cash Calculator
Section two is focused on the money you are going to need to initially invest in the property. This includes the purchase price, down payment, closing costs, repairs, and other start-up costs such as furniture.
When entering the purchase price, we often play around with the number to help see at what price point the cash-on-cash return works.
The down payment amount can vary depending on the type of loan you secure. If you use a second-home loan, for example, you can put down as little as 10% for a down payment. Second home loans, though, do have restrictions the first year. So, you want to be aware of them before you commit to using a second home loan.
If you are using a residential/conventional loan and buying a multifamily property to use as a short-term rental or you own a number of other rentals, you’ll likely be putting a minimum of 20% down and even up to 25% down. You’ll need to check with your investor-friendly lender to determine the best loan product for you.
Closing costs generally range from 1-3% of the purchase price. Your lender can supply this information once you are under contract, so you’ll want to guesstimate it initially.
Consider Costs and Repairs in Your Short-Term Rental Cash-on-Cash Calculator
Until you do the inspection, you’re not going to have a complete view of the costs of repairs and renovations. In your initial cash-on-cash calculation, you’ll want to estimate this. Major things to consider include whether the property needs a new roof, outside painting or siding, any landscaping, interior renovations, interior painting or any additional bathrooms or bedrooms. When you do the inspection, ideally have at least one contractor come on site to give you an accurate bid.
Also, we encourage you not to waive your inspection or other contingencies under any circumstances. You want to be able to predict all the costs to know how your property will perform prior to purchase. Otherwise you are taking on risk blindly. That’s when major errors happen – and you end up with a liability, not an asset.
In the repairs/renovations section you’ll also want to include any repairs that you believe will need to happen in the next couple years. For example, after your inspection, you might find out that your hot-water heater probably has only 2-3 years left. In that case, I’d factor that into the repairs at time of purchase, because it’s a capital expense that you know you have coming down the pipeline soon.
Finally, in the second section, you should include any other start-up expenses you didn’t already include in your repairs/renovations such as furniture, a pool table, outside games, outfitting the kitchen with pots, pans and silverware, towels, gym equipment etc…
Section 3: Loan Data For Your Short-Term Rental Cash-on-Cash Calculator
Section three is where you include the details of your loan.
As you can see the amount financed is a white cell, so you shouldn’t touch it. It’s already calculated for you based on the purchase price you entered and the percent down.
The interest rate you’ll get from your lender. Note, it will likely be higher than a primary residence since you’re buying as non-owner occupied (unless you are using the second home loan). If the STR is a multifamily property, this usually adds another 0.5% to the loan interest rate as well.
Finally, in most cases you’ll be doing a 30 year loan with 12 payments per year if you’re using a residential/conventional loan.
Section 4: Expense Data For Your Short-Term Rental Cash-on-Cash Calculator
The short-term cash-on-cash calculator includes far more variables than the long-term cash-on-cash calculator in the expense section. There are numerous additional costs associated with running a short-term rental.
To get the most accurate prediction of property taxes, you’ll want to either call the city or find the local mill rate to help you calculate what they will be after purchase. It’s not going to be accurate if you use current property taxes in your calculations. Generally, you are buying the property at a higher price than the previous owner did. Therefore, the city will reassess your property taxes after purchase. Usually this means a bump in taxes the year after purchase. Sometimes taxes alone will break a deal.
If you’re in a position of running a calculator and you must act fast (and don’t have enough time to call the city or can’t find the mill rate online), I’d recommend slightly bumping property taxes in your initial cash-on-cash calculator. This will depend on how long ago the property was purchased and at what price (look at previous purchase data under your Redfin or Zillow app).
When entering the insurance numbers, you can either use what the current owner is paying or an estimate of cost per square foot from your insurance broker. Ultimately, you’re not going to have accurate numbers for this variable until you have your inspection. You need to have insight on the type and status of the electrical and plumbing systems and have a good assessment of the roof. If there is a pool or the property is near a body of water, I’d be more likely to use what the current owner is paying, since insurance is likely significantly higher due to these factors. Flood insurance, for example, can be quite expensive.
Keep in mind that short-term rental insurance is also going to be higher than what you’d pay for (and therefore put into) your long-term rental cash-on-cash calculations.
The HOA section should be populated with the monthly fees associated with a HOA, if applicable. These will likely increase over time, though the hope is your property’s rental rate will also increase similarly. If you are buying a condo, you may want to try factoring higher HOA fees and see how that affects your COC, since you don’t have any control over what the HOA will do.
If you are considering buying a condo as a short-term rental, please also check out Is a Condo a Good Investment. This will help ensure you are aware of some of the possible downsides of investing in condos as rentals.
Property Management Fees
Property management fees as a percentage cost per month should be collected from your property manager. Short-term rental property management companies generally charge between 20-30% per month in fees.
If you are planning on self-managing, we would recommend running the numbers for every property to include property management fees. This allows you the freedom to be able to use a property manager down the road if, for some reason, you aren’t able to or no longer want to self-manage. The last thing you want is a liability. If you don’t factor in local property management fees, you are setting yourself up to see inflated returns.
Moreover, by factoring in property management fees up front, you can compare properties apples to apples. For example, let’s say you buy a local short-term rental and self-manage. You don’t factor in property management but buy a long-distance short-term rental and use a property management service. That distant long-term rental may look like it has inferior cashflow. When, in fact, it may be a better purchase compared to what you have locally. You’re just supplementing the local one with sweat equity.
Your maintenance cost percentage will generally run between 5-10%. If you have a newer property (or one you recently rehabbed), you might put it closer to 5%. If you have an older building, a pool or you want to be more conservative, you’ll probably want to choose 10%.
Keep in mind that your maintenance for a short-term rental is likely to be higher than for a long-term rental. Kenji and I usually rehab our long-term rentals upfront, so we use 5% for maintenance. In comparison, I always include 10% maintenance in our short-term rental cash-on-cash calculations. This accounts for furniture and other damage from increased wear and tear.
Booking Fees are fees associated with listing your property online on platforms like AirBNB or VRBO. If you have a property manager, he/she may also cover these fees. Booking fees will often run in the 3-5% range if you are self-managing. If you have bookings come through your own property website and not through AirBNB or VRBO, ensure you collect credit card fees and book back any applicable taxes to guests.
Hint: one way to potentially reduce your booking fees and save your guests from paying guest service fees is to create your own property listing. Get repeat customers to book on that rather than on AirBNB or VRBO.
Lodging Tax encompasses taxes paid to the city or municipality for operating your short-term rental. They can be quite significant. For example, in Hawaii, the state charges 14% for lodging taxes. Oftentimes lodging tax can also be passed on to and covered by the customer.
Monthly Supplies, and other monthly costs are included to capture repetitive costs that will need to be covered by yourself as the owner of the short-term rental.
Monthly supplies are things like soap, shampoo, paper towels or laundry detergent. Sometimes your property manager will also include this cost as part of your fees. For example, we pay our property management 30% of fees collected. This includes them re-stocking the property with the necessities for each guest’s stay.
You will want to include the average monthly cost of water, sewer, garbage, electricity, and gas, if applicable, into utility costs. If you have a septic system, make sure to factor in pumping it yearly into your maintenance. If this is not necessary, you’ll just get a higher COC return. In addition, you’ll want to build in the costs of landscaping, pest control or even propane refills for your grill.
Monthly cable and internet includes those services plus others including subscriptions to Hulu, Netflix, Disney Plus, etc…
In addition to the above, you need to include all the other things you pay each month. For example, we pay $85 a month for hot tub maintenance for our cabin.
The Calculations in the Short-Term Rental Cash-on-Cash Calculator
You won’t need to touch the cells in the calculations area of the cash-on-cash calculator. Using the peach-colored columns (use % vs monthly vs yearly data for the appropriate cells), your monthly net operating income, cash flow and cash-on-cash return will be calculated automatically.
Your monthly and yearly net operating income combines the amount you bring in from rent, and subtracts out all expenses except your mortgage.
In your monthly/annual cashflow, you deduct your mortgage cost (if you pay all cash and don‘t get a loan, this should be zero) to find out how much money your property should put into your pocket each year once everything is paid for.
Note: the monthly/annual cashflow may not seem like very much, but remember you’re earning other ways including having your customers pay down your mortgage, the tax benefits and likely market appreciation (and ideally forced appreciation), that you haven’t built into this calculator.
If you want to get an overview of all the ways your property is making your money, check out this article.
Your total investment represents all the money you’ve put into the property. Which includes your down payment, closing costs, rehab and other start-up costs.
We’re finally to the most important part of the cash-on-cash calculator: your return!
Your cash-on-cash return represents the percentage you make each year on the money you put into the property. It’s synonymous to what you get in returns year after year from the money put into the stock market, for example.
Having positive cash-on-cash return means you have an asset, not a liability.
It is also provides your cushion to get through tough times.
As I mentioned earlier, members of our community generally aim to get >20% cash-on-cash return from short-term rentals (with property management costs included).
This is a higher percentage than we generally aim for with long-term rentals. This is because there is often increased risk associated with owning short-term rentals. Especially if you don’t have a back up plan that cashflows. Such as renting your property as a long-term rental if HOA rules change. Or there is a downturn or another COVID shut-down and vacation bookings drop through the floor. If your STR is an expensive single-family home in a vacation area, you also have increased concentration risk (lots of money in one property) and more exposure when the downturn comes. SFH’s value oscillates more than long-term multifamily rentals. Plus, a lot STRs also require more work, especially if you don’t have a property manager.
For all those reasons, we as a community demand higher cash-on-cash returns to have a higher buffer of yearly cashflow to handle any bumps in the road.
What’s the right amount of cash-on-cash return for me?
Does all of that mean that you shouldn’t buy a short-term rental with 12% cash-on-cash return?
Well, not exactly.
Each investment comes with upsides and downsides, risks and motivations. As well as what you are willing to accept in terms of returns.
As an example, Kenji and I bought a short-term rental with a cash-on-cash return of 15% (with a 30% management fee). We wanted to be able to own a property in the area and use it as our primary residence if necessary. We already have a significant portfolio of long-term rentals that provides our cashflow buffer. At the time of this writing, we’re well over 100 units. So, we were willing to accept lower returns from this one property in the greater context of our portfolio. That property alone also generated almost $300,000 in a tax shelter for us.
As with everything in real estate investing, what’s right for us may not be what’s right for you.
So, lean on your goals and your why and your financial experts, like your CPA to help you determine what fits you.
Where to go from here
Want to get into short-term rentals?
Join our course, Accelerating Wealth: Blueprint for Short-Term Rentals to learn how to find and buy good deals, and how to run a portfolio of cashflowing short-term rentals. The focus of the course is to help accelerate your journey to financial freedom! It’s open to join all year, so you can sign up anytime!
Have you found a way to creatively fund your real estate portfolio and achieve financial freedom? Join the conversation! Follow our Semi-Retired MD Facebook page and join our Physicians (for MDs or DOs only) or Professionals group!
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