Adjusting Your Cap Rate Calculation for Short-Term vs. Long-Term Rentals

When evaluating the profitability of a property, the cap rate is one of the most important metrics real estate investors use to evaluate property performance.. However, for real estate investors involved in both short-term rentals (such as vacation properties or Airbnb listings) and long-term rentals (traditional leasing), it’s crucial to understand how to adjust the cap rate calculation based on the type of rental. The dynamics of short-term and long-term rentals differ significantly, influencing both net operating income (NOI) and property value—two key components of the cap rate formula.

In this post, we’ll explore how to adjust your cap rate calculation depending on whether your property is a short-term rental or a long-term rental. By understanding these adjustments, you’ll be able to make more accurate comparisons and better-informed investment decisions.

The Key Differences Between Short-Term and Long-Term Rentals

Before diving into how to adjust your cap rate calculation, it's important to first understand the fundamental differences between short-term and long-term rentals:

• Short-Term Rentals (STRs): Typically rented out for a few days or weeks, often to vacationers, tourists, or business travelers. These rentals are usually listed on platforms like Airbnb, Vrbo, or Booking.com and tend to have higher nightly rates but also experience fluctuating occupancy rates.
  
  
• Long-Term Rentals (LTRs): Rented for extended periods—usually 12 months or longer—to tenants who are looking for stable housing. These properties typically generate steady monthly rental income and often come with lower turnover and more predictable income compared to short-term rentals.
  
  

Each rental type comes with its own set of dynamics that can affect your net operating income (NOI), and therefore, your cap rate. For both rental types, the goal is to assess how much income the property generates relative to its value, but the methods for calculating NOI differ based on the rental strategy.

How to Adjust Cap Rate for Short-Term Rentals

Short-term rentals tend to have more volatile income due to seasonality, occupancy rates, and pricing fluctuations. These factors must be accounted for when calculating the cap rate. Here are the key considerations when adjusting your cap rate for short-term rentals:

Variable Income and Seasonal Adjustments

Since short-term rental income is not consistent month-to-month, it’s essential to account for seasonal variations when calculating NOI. For example, a beachfront property may generate high income during the summer months but experience a significant drop in the off-season. To accurately calculate your cap rate for short-term rentals, you should:

• Analyze historical data: If possible, use data from previous years to predict seasonal fluctuations in rental income.
  
  
• Adjust for low-demand months: If you anticipate low occupancy during certain months, be sure to lower the income expectations for those months to reflect realistic earnings.
  
  

Higher Operating Expenses

Short-term rentals tend to incur higher operating expenses compared to long-term rentals. These expenses include:

• Cleaning fees (often between guest stays)
  
• Utilities (typically covered by the owner in short-term rentals)
  
• Property management (if you hire a service to handle bookings and guest communications)
  
• Supplies (toiletries, bedding, and other guest amenities)
  
  

Because of these higher expenses, your NOI may be reduced, which could lead to a lower cap rate when compared to long-term rentals. It’s essential to accurately track and include all short-term rental operating expenses in your calculation.

Fluctuating Vacancy Rates

Short-term rentals often experience higher turnover and may have vacancy periods between guests. While high-demand seasons can lead to higher occupancy, vacancy rates during the off-season can dramatically affect your annual income. To adjust for this:

• Account for vacancies: Factor in your expected occupancy rate for the year, based on historical data or market research. For example, if your property is likely to be rented 70% of the year, make sure your cap rate is based on annualized rental income for that occupancy rate.
  
• Consider market trends: In certain locations, such as popular tourist destinations or big cities, vacancy rates may be lower, helping to offset off-season fluctuations.
  
  

Pricing Strategy

Another key element for short-term rentals is the pricing strategy. Many short-term rental owners adjust their rates dynamically based on factors like local events, seasonality, and demand. Dynamic pricing tools can help optimize rates for maximum revenue, but they also require careful tracking to ensure you’re not overestimating potential income.

Ensure that your NOI is based on realistic rental rates, considering all the factors that affect occupancy and pricing.

How to Adjust Cap Rate for Long-Term Rentals

Long-term rentals, on the other hand, offer a more predictable and steady income stream, which makes the cap rate calculation somewhat simpler. However, several adjustments are still necessary to ensure your cap rate reflects the true return on investment.

Steady and Predictable Income

Since long-term rental income is more stable, you don’t need to adjust for seasonality or fluctuating pricing. Monthly rental income remains consistent, provided the tenant pays rent on time and stays for the duration of the lease. However, you still need to consider:

• Rent collection: Ensure your rental income is accurately reported, factoring in any late payments, partial months, or missed payments.
  
• Tenant turnover: Long-term rentals have lower turnover compared to short-term rentals, but it’s still important to account for vacancy periods between tenants. Estimate the expected vacancy rate based on your market’s average turnover rates.
  

Lower Operating Expenses

Operating expenses for long-term rentals tend to be lower compared to short-term rentals, as many of the costs (like cleaning services, utilities, and amenities) are either covered by the tenant or are minimal. Key operating expenses for long-term rentals include:

• Property management fees (if applicable)
  
• Maintenance (routine repairs, landscaping, etc.)
  
• Insurance
  
• Property taxes
  

Since these expenses are typically lower than those for short-term rentals, your NOI may be higher, potentially resulting in a higher cap rate.

Minimal Vacancy Rates

Long-term rentals typically experience lower vacancy rates than short-term rentals. Once a tenant signs a lease, you generally have consistent monthly income for the length of the lease term (typically one year). However, it's still important to account for potential vacancy during tenant turnover. While this is less of an issue than with short-term rentals, a few weeks of vacancy can still impact the NOI.

Rent Increases and Lease Renewals

For long-term rentals, it’s important to factor in any potential rent increases, especially in growing markets where property values and demand are rising. Some leases may have clauses allowing for annual rent increases, which could boost your NOI over time. These increases can affect your cap rate in subsequent years, improving profitability.

How to Adjust Cap Rate for Both Rental Types

If you’re managing both short-term and long-term rental properties, you’ll need to apply different adjustments to each property’s cap rate calculation based on its specific income stream and operating expenses. For example, a mixed-use property with both short-term and long-term rental units may require separate calculations for each segment to get a more accurate cap rate for the entire property.

Here’s how you can handle it:

• Calculate the cap rate separately for short-term and long-term rental units, factoring in the specific income, expenses, and occupancy rates for each.
  
  
• Combine the NOI from both rental types, adjusting for the differences in income stability and costs.
  
  
• Determine an overall cap rate for the property by weighting the contributions from each type of rental based on the number of units or the proportion of income they generate.
  

Conclusion

Understanding how to adjust cap rate calculations for short-term vs. long-term rentals is essential for making informed investment decisions. Short-term rentals come with higher income volatility, increased operating expenses, and seasonal fluctuations, all of which need to be factored into the cap rate calculation. In contrast, long-term rentals offer more stable income and lower expenses but may require adjustments for tenant turnover and rent increases.

By factoring in these differences, you can get a clearer picture of your investment’s true profitability and make decisions that align with your financial goals. Whether you’re managing a vacation property or a long-term rental, adjusting your cap rate calculations based on the rental type will help you assess each investment more accurately and optimize your returns.

Happy investing, and may your rental properties bring you steady success! For more strategies on optimizing your vacation rental’s income and Cap Rate, visit the Vacation Property Expert Network: 👉www.vacationpropertyexpertnetwork.com.