Airbnb, permanent rental or granny flat: which produces the better return?

In my previous article I looked at what can happen to the main residence capital gains tax exemption when part of the family home starts producing income.

I used two examples. The first involved spending around $30,000 converting an unused garage or part of an existing home into a self-contained studio with its own bathroom and small kitchenette. The second involved spending $200,000 building a new two-bedroom granny flat.

There is also a third option worth considering.

Instead of operating the $30,000 studio as short-term accommodation through Airbnb, it could simply be rented to a permanent tenant for around $350 a week.

That gives us three quite different ways of producing additional income from a property you already own.

Not every property will suit all three, of course. A granny flat requires sufficient land and a studio conversion requires an existing part of the home that can realistically be separated. But where the options are available, putting them side by side raises an important question.

It is not simply which option produces the highest rent. It is how much capital you need to commit to produce that income, what it costs to operate and what you are left with at the end.

A full comparative table appears at the end of this article.

The $30,000 Airbnb conversion

Assume the homeowner has an underused garage or section of the house with suitable access that can be separated from the main living areas. Around $30,000 is spent turning it into a self-contained studio with a bathroom and small kitchenette.

At an average of $200 per night and 50 per cent occupancy, the studio generates gross income of around $36,500 a year. The first year’s gross income is already greater than the cost of the conversion and, on those numbers, the original $30,000 is recovered from gross revenue in less than 10 months.

Over 10 years the studio could generate around $365,000 before allowing for any increase in nightly rates.

The obvious qualification is that gross Airbnb income is not profit. Short-term accommodation has higher running costs, including cleaning, linen, electricity, water, platform fees, consumables, furniture replacement and additional wear and tear. There is also the time involved in bookings, guest communication and constant turnover unless the management is outsourced.

If we allow 35 per cent of gross income for those costs, the indicative annual income falls from $36,500 to around $23,700 before interest, depreciation and income tax. That is still a strong return from a $30,000 conversion, but it comes with considerably more work than collecting rent from a permanent tenant.

What if you simply rent the studio for $350 a week?

The same studio could instead be rented permanently for $350 a week, producing $18,200 a year or $182,000 over 10 years before rent increases.

The income is roughly half the Airbnb figure but the capital required is exactly the same $30,000. The conversion cost is recovered from gross rent in around 20 months.

The main difference is simplicity. There are no regular guest changeovers, continuous booking management, linen to organise and no need to constantly manage nightly rates or reviews.

There will still be normal rental expenses and possibly property management costs. If we use an illustrative 10 per cent allowance, annual income after those costs is around $16,400.

The comparison with Airbnb therefore becomes a little different once expenses are included.

On the gross numbers Airbnb produces an additional $18,300 a year. After applying the running-cost assumptions above, the gap falls to around $7,300 a year, or approximately $140 a week.

The question for the homeowner is whether that additional $7,300 is enough compensation for operating a small accommodation business.

For some people it will be. For someone working full-time or who simply does not want strangers regularly coming and going from their property, $350 a week from a $30,000 conversion may be the more attractive outcome.

Then there is the $200,000 granny flat

Now assume instead that the property has enough land for a completely separate two-bedroom granny flat at a construction cost of $200,000.

At $600 a week it produces gross rent of $31,200 a year, which represents a gross return of 15.6 per cent on the construction cost.

Using the same 10 per cent running-cost allowance as the permanent studio, indicative annual income is around $28,100 before interest, depreciation, capital works deductions and income tax.

Viewed on its own, those numbers look particularly good. However, the comparison becomes more interesting when we consider the additional capital required.

The $30,000 studio rented permanently produces $18,200 of gross annual rent. The $200,000 granny flat produces $31,200.

You have therefore committed another $170,000 to generate an additional $13,000 a year in gross rent. That additional $170,000 is earning about 7.6 per cent gross, but once you look at the decision this way you have a much better basis for comparing it with what else that $170,000 could be doing.

The opportunity cost of the extra $170,000

If the extra money needs to be borrowed at 6 per cent, the interest alone is around $10,200 a year.

Against the additional $13,000 of gross rent generated by the granny flat, that leaves only about $2,800 before allowing for additional rates, insurance, maintenance, vacancy and tax.

Even if the homeowner already has the money sitting in cash, there is still an opportunity cost.

Putting $170,000 against a home loan charging 6 per cent would save $10,200 a year of non-deductible interest. For someone on a 39 per cent marginal tax rate, including Medicare levy, they would need to earn around $16,700 before tax elsewhere to end up with the same $10,200. That is equivalent to a pre-tax return of approximately 9.8 per cent.

This does not mean paying down the mortgage is automatically the better choice. It simply shows why comparing investment opportunities on rent alone can be misleading.

How you use the cash matters too. Paying it off the home loan and then borrowing to build the granny flat will generally make that interest deductible, because the new borrowing funds an income-producing asset. Spend the cash on the build and borrow for private purposes later, and that interest will not be deductible. It is worth getting the loan structure right before you start.

Capital can only be used once and what you choose to do with it matters.

What do the numbers look like over 10 years?

Ignoring rent increases, the Airbnb generates approximately $365,000 of gross income over 10 years from the $30,000 conversion. The permanent studio produces $182,000 from the same initial investment while the granny flat generates $312,000 from a $200,000 build.

Subtracting the initial capital cost leaves $335,000 for the Airbnb, $152,000 for the permanent studio and $112,000 for the granny flat before ongoing costs, financing and income tax.

In the CGT examples used in my previous article, calculated under the existing rules with the 50 per cent discount applied to the whole gain, the estimated future capital gains tax was approximately $13,750 for the studio and $29,250 for the granny flat.

Using those assumptions leaves approximately $321,250 for the Airbnb, $138,250 for the permanent rental and $82,750 for the granny flat after deducting the original construction cost and illustrative CGT, but before allowing for operating expenses.

However, we have already established that each option has different running costs.

If we also deduct the estimated annual operating expenses over the 10 years, the comparison changes to approximately $193,500 for Airbnb, $120,050 for the permanent studio and $51,550 for the granny flat.

These figures are not profits or overall investment returns. They are simply the rental cash generated over 10 years less the initial capital invested, assumed operating costs and illustrative CGT. They exclude financing costs, annual income tax, depreciation, rent increases and changes in the value of the property.

Importantly, they also do not allow for the value added to the property by the improvements. This is particularly relevant for the granny flat, where the $200,000 construction cost has created a separate dwelling that remains part of the property.

The CGT rules are changing

The CGT figures also use the existing 50 per cent discount. As explained in Part A, from 1 July 2027 this will generally be replaced by CPI indexation and a minimum 30 per cent tax rate on relevant capital gains.

With our assumed marginal tax rate of 39 per cent including Medicare levy, the minimum rate itself would not ordinarily affect the couples. However, replacing the 50 per cent discount with CPI indexation could change their eventual CGT liability.

The existing discount treatment remains relevant for eligible gains accrued before 1 July 2027 and qualifying new residential builds may have a choice of CGT treatment.

The figures used here should therefore be treated as illustrations under the existing rules rather than forecasts of the tax payable on a sale 10 years from now.

The granny flat is still an asset

The $200,000 spent building a two-bedroom secondary dwelling has not simply disappeared.

A properly constructed granny flat is a permanent addition to the property and may add significant value when the property is eventually sold. It also creates flexibility that a converted studio may not offer. It could remain a rental property or later provide accommodation for adult children, ageing parents or other family members.

There can also be capital works deductions during the rental period. On a $200,000 build, deductions at around 2.5 per cent could potentially be approximately $5,000 a year, subject to the nature and timing of the expenditure. Over 10 years this could represent approximately $50,000 in tax deductions.

Those deductions generally reduce the relevant CGT cost base and can increase the taxable gain when the property is eventually sold, although the actual CGT impact will depend on the applicable valuation and cost-base rules. The annual tax benefit is still relevant, so we cannot simply treat the $200,000 construction cost as money that has been consumed.

Equally, spending $200,000 does not guarantee that the property will immediately become worth $200,000 more. The amount of value added will depend on the property, location, quality of the build and what future buyers are prepared to pay for a secondary dwelling.

That needs to be assessed before committing the capital rather than assumed afterwards.

Which option comes out ahead?

If the sole objective is to generate the greatest income from the least amount of additional capital, the $30,000 conversion is difficult to beat.

Whether that studio is better operated through Airbnb or rented permanently comes down largely to the value you place on your time and how much of the higher short-term rental income survives the additional operating costs.

The Airbnb generates considerably more gross income. Once we allow for higher running costs the advantage narrows, but on the assumptions used here it still produces around $7,300 more each year than the permanent rental.

The permanent tenant provides a much simpler income stream and still produces a strong return on the $30,000 spent creating the accommodation.

The granny flat requires substantially more capital. In return, it produces higher rent than the permanent studio and leaves you with a separate two-bedroom dwelling that may add considerably more long-term value and flexibility to the property.

That is why I would not make this decision based on whether one option earns $200 a night, another $350 a week and another $600 a week.

If spending $30,000 can create a viable $350-a-week rental, then the relevant question before spending another $170,000 on a granny flat is what that additional capital is actually buying you and whether the extra rent, property value and future flexibility justify it.

Likewise, if you are considering Airbnb, the headline nightly rate is only part of the story. What matters is how much you actually retain after the additional costs and whether that premium is worth the extra work.

Looking at the income, capital required and eventual value of what you have created gives you a much better basis for making the decision than weekly rent alone.

Summary of the three options