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 means the profit you make on your investment. ROI is expressed as a percentage of the cost of the investment. How you calculate your ROI on a rental property depends on whether you paid in cash or got a mortgage. You’ll also need to factor in closing costs, taxes, maintenance and repair costs, utilities, insurance, and other costs. For a rental cabin, costs could include--just as examples--Wi-Fi bills if you’re providing free Wi-Fi to your guests, maintenance bills for a hot tub, or fees you pay a property management company to book guests.

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Let’s walk through an example from Investopedia. 

Basic ROI 

The simple formula for ROI is

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

In other words: Take the amount you made in rental money, subtract the costs for running the cabin, and then divide what’s left by the amount you paid for the cabin. The result is your ROI. A simple example: 

  • You pay $100,000 for a cabin in cash, without a mortgage loan. 
  • You also pay $1,000 in closing costs and spend another $9,000 on renovations. Your total investment is $110,000.
  • Over a year, you earn $12,000 in gross rental income from the cabin.
  • Over that year, you have expenses of $2,400 on property taxes, insurance, and utilities. 
  • Subtract the expenses, $2,400, from the income of $12,000. That leaves you $9,600. This $9,600 is called your annual return. 
  • Divide the annual return by the amount of your investment and you’ll get your ROI. In this example, you’ll divide $9,600 by $110,000. The result is 0.087, and for ROI, you turn that into a percentage, 8.7 percent. Your return on investment for your cabin that year is 8.7 percent. 

Here are those steps plugged into the formula:

(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 you finance your cabin, instead of paying for it outright in cash, is more complex. Your annual return, the money you get from rentals, will be lower because you’ll need to subtract what you must pay in interest on the mortgage loan. But your ROI may end up higher than if you paid for the cabin in cash. Why? The ROI could be higher because your initial investment is lower--a down payment plus closing costs are going to be less than paying in full for the property. 

What’s a “good” ROI on a rental property?

The answer is, “It depends.” Some owners will be fine with a lower ROI on a property that’s costlier but is in a solidly reliable location that draws renters very consistently. Other owners may crunch numbers and decide they won’t even look at properties that bring in less than a certain specific ROI. 

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

If you’re thinking of becoming a cabin owner, don’t go it alone. Talk to cabin management experts who know the market and who can take the hassles of running a rental cabin off your hands. Contact Colonial Properties Cabin and Resort Rentals today.