Do you want to invest in an Airbnb but are afraid you'll buy a property that won't cash flow? Does the fear of making a mistake stand in your way of Airbnb investing?
If so, you need to listen to Episode 15 of the Host Coach Airbnb podcast where we discuss how to underwrite property and our three favorite ways to calculate its return on investment before you buy it so you can be confident in your buying decision and cash flow generation.
Let's dive in!
Underwriting is a topic that we've got a lot of questions about recently, and it is one of the most important parts of becoming an Airbnb investor. It's how to understand is this property going to cashflow? Is it going to make money? Simply put, underwriting is just understanding your expenses and your potential income.
Every time I hear underwriting, I die a little bit inside because I imagine these troll people in the basement of the mortgage firm and the people that crunch all the numbers and decide that I can't have a mortgage. But fortunately with Airbnb investing, that is not the case.
How to Underwrite an Airbnb
Underwriting is actually easy and straightforward. So let's start with the income side of things, because that can be a little bit tricky. First, you need to have a property in mind. If you don't have a property in mind, you could just run this one in your own house, go to Redfin, or find a potential property.
And this is free, cheap, and easy to do. Short-term rental income can be art and science. It can be really tricky, but luckily we have a friend in AirDNA, remember, we've used AirDNA to evaluate markets. AirDNA also has a tool that helps us evaluate a very specific property.
So if you have a property address, you can go to AirDNA, there's a tool called Potential Earnings Calculator. You can enter that target properties. Address into Air DNA and it will start to do some projections for you. It will look at comparable listings in the market, in the area of your target property, and it will give you a overall estimated annual revenue for that property.
The tool will give you estimated average daily rate and estimated occupancy based on the market. However, if you scroll down a little bit further from that overall estimate, which is a good metric, we can find the comparables that were being used to create that average estimate.
When you look at the comparables, you can find a property that's maybe most similar to the one that you are looking at. And you'll see specific, not average, but specific, revenue for that property, and that property's occupancy. What we find is that average occupancy in a market is often low, 40% to 50%. But, if you've been listening to this podcast for a little while, you'll know that we're not 40% or 50% occupancy kind of people.
We're targeting 90% to 95% Airbnb occupancy. So if you scroll down, you can find a couple of properties that are most similar to the property that you're interested in, and that will give you a revenue number for the property that would be similar to what you're looking for.
By most similar, we mean same number of bedrooms, same number of bathrooms. If you're looking at something that looks like a cabin and find a comparable, that looks like a cabin, not a house, all of those things help you have the most accurate potential number.
I would also recommend looking at the occupancy of that property. Let's say it's 50% occupied and calculate a revenue number at a higher occupancy, like 75%. Also, consider your target property's proximity to amenities. Is it near the downtown area where people are going to want to travel to? Is it near lake access that people are going to want? Is it near that national park? So other than just this address, we want to consider its proximity to thhe draw for the area.
We also, from an occupancy perspective, want to look at regulation. If that address is in a regulated homeowners association, then our occupancy obviously is going to be zero. We also want to look at and evaluate the quality, the curb appeal, of that target property. Does it look like a cabin - if it's in a cabin area? Does it look like a historic home - if it's supposed to be in a historic downtown?
Now it's time to break out the spreadsheet because we gotta start putting these numbers somewhere.
Culin loves spreadsheets. Get ready!
How to Calculate Airbnb Expenses
So our biggest expense, obviously, is going to be the mortgage on the property. There are many good mortgage calculators out there. I like the one from Bank of America. It's very straightforward. Or you can call your favorite mortgage broker and they'll be happy to talk about these kind of numbers with you. I put in a $250,000 house with a 10% down payment. The calculator came back with a principal and interest payment of $1,440 per month.
The Bank of America mortgage calculator also comes up with estimates for property tax and estimated homeowner insurance. So we're flying down the spreadsheet now we're plugging in these numbers. Next we're going to come to our cleaning fee. We budget 12 turnovers a month.
That's 2.3 days per guest, 12 turnovers a month, at $60 per turnover. You're going to want a budget category for minor repairs and expenses. Little things that get broken, little things that need to be fixed. Budget a couple hundred dollars there. Then you can get estimates on your utilities for your electric water and internet.
Maybe even a little lawn maintenance if you've got to mow the lawn, and $20, $30 for cleaning supplies. We've got that all filled in. Now we know all of our expenses. We've got a copy of this on page 38 of the Host Coach Book. Drop me a note or an email. I happy to send you the template.
So we've got approximately $1,500 in mortgage expense, approximately $1,500 in other expense for a total expense category of $3,000. Revenue less expenses is cashflow. So at $4,000 in estimated revenue, less $3,000 in expenses, we have now underwritten this property to show a $1,000 per month cashflow.
So you have to ask yourself, is that good? It depends on your goals. I was talking to a client this morning whose goal was to own a condo at the beach. She didn't need it to make money. She just needed it to break even, so that a thousand dollars a month cash flow is exceeding her goals. However, if you are looking at this property to maximize your return on investment, is a thousand dollars enough cash flow? Are the expenses too high or is the revenue too low?
You may begin now to compare this property against other properties. Maybe there's a less expensive property. Maybe there's a similarly priced property that's is going to cash flow better and we can now start to compare one property to the next. And we are now underwriting deals.
Airbnb Startup Expenses
But hang on a second! Don't forget to factor in startup expenses. So these are things like renovations, cost for new furniture, dishes, linens, paint, outdoor amenities like hanging basket chairs. I love those. For our properties, we budget between $10,000 to 25,000 for startup expenses. But, every property is different. If you have a turnkey investment, that can be a much lower figure, maybe even $2,000 to $4,000. If its two thousand dollars applied to a small two bedroom. That's actually a lot of impact with paint, keeping the original furniture and changing out bedspreads
If it's an extra crispy property (and I love those) that startup figure can be way more than $25,000. So factor those things in to get a really accurate representation of money in versus money out.
Why Underwriting Your Airbnb Purchase Matters
And I know this sounds like a lot and it is, but calculating costs associated with operating your Airbnb will help you make a sound decision on whether a property will cash flow the amount you want or if it won't. We get this question all the time, which is why we made this episode. "How can I make sure that I'm investing in a property that's going to cash flow?"
We're telling you. Do not fall in love before you underwrite and establish your goals. So if cashflow is your goal, no matter how lovely, quirky, or crispy a non-money making asset is, it is a waste of your money and time. Do not be a dumb investor and just hope that you get lucky and buy the right place.
This is your money. This is your savings. This is not a hope and a prayer situation. So do the due diligence of underwriting and then use those figures and at least one of our systems to gauge the profitability of a listings potential. As an Airbnb investment shop, smart, it's your money and it's your financial freedom that we're talking about.
The 1% Rule
So the first way to assess the profitability of a property is using the 1% rule. The 1% rule is a real quick metric that's often used for any type of real estate investing such as multifamily or a long-term rental. It basically means if you're spending $250,000 for a property, that property on a monthly basis should generate $2,500 in revenue.
However, in short-term rental, the mortgage is really only half of our expenses, so I apply a 2% rule to short-term rental investments. A 2% test would mean that $250,000 property should gross $5,000, and that's a sound investment.
With proper selection, set up, and management, your Airbnb investment can pass a 2% rule or even more. So what do we mean by proper selection, set up, and management? Selection is selecting the right property, right? It's proximity to draw, as we mentioned. Are there views? We like to say it can't build a view. Does the place have curb appeal? Is it nicer than the other places? Is it unique? Is it a place where people are going to want to go? So outside of just the address and the numbers, selecting the right property from a aesthetics perspective makes all the world of difference.
Next is proper setup design with the guests in mind, right? Buy those amenities, have a hanging basket chair, a fire pit, all the things that people don't have in their own homes that they're looking for in an Airbnb stay to make that listing really pop. And obviously high definition professional real estate photos to make it pop.
Finally, as far as proper management: are you going to be an attentive host? Are you going to go above and beyond for your guests? Will you be quick to respond, really giving them that great concierge experience. Are you going to use, dynamic pricing, a third party pricing tool to make sure that you're meeting the market every day and keeping that listing full?
Again, occupancy is so key in not just success on the Airbnb algorithm, as we've talked about a lot, but also key in your underwriting, and in your profitability. That 40% occupied property might just break even, but the 75% occupied property is where you're really going to move the needle on your return on investment.
Another thing is to make sure you have a great team. We talked about that in Episode Six of the Host Coach Show, so make sure that you have an amazing housekeeper and you've set yourself up with for success as a host by having a team of individuals who can help if there's issues or maintenance needed on your property.
Cash On Cash Return
Cash returns is another great metric for evaluating where to spend your valuable capital. This metric measures the total capital invested against the net annual income from the property. So for example, if you have a $250,000 property. You put 10% down, put in $25,000 to renovate it and outfit it, that's $25,000 spent in improvements.
So you have invested $50,000 of your hard earned capital. If that property nets $5,000 for the year, that's 10% return on investment. Kinda like the stock market, maybe a little bit better. But, we're going to hope to do better in the stock market and we're going to be working a little bit harder. This isn't completely passive income, if you're netting a thousand dollars a month, that's $12,000 net income for the year, and that's a 24% cash on cash return invested $50,000, received $12,000 in cash flow, that's a 24% return. That's pretty good. Or if you're receiving $2,000 a month in cash flow, that's $24,000 for the year and a 48% return, that should definitely beat the stock market!
So you can see how attractive a short-term rental can be based on these returns on the capital invested. You have a lot more control over your Airbnb than the stock market. There's all of these crazy variables in the stock market, and while I do believe in having that managed professionally, I don't want to deal with it.
I can understand how to run an Airbnb. I can understand plugging in pricing tools and designing with guests in mind. And so to have that knowledge and ability to change profit from $1,000 a month to $2,000 a month andg generate 48% cash on cash return, that's exciting! That's that's where the good stuff is in my opinion.
Average Daily Rate vs. Price Per Square Foot
A third way to figure out the profitability of a potential property is average daily rate versus price per square foot. Culin came up with this, and I think it's the simplest way to evaluate a property for Airbnb investing. So look up the average daily rate of other Airbnbs in your area by looking at AirDNA .
Figure out the average daily rate paid by guests to stay at a place that's the same or pretty close to the property you're looking at in terms of number of beds, baths, etc. Now look at the cost per square foot of that property.
If the property is priced at $200 per square foot and the average daily rate is over $200 a night, then you have a good investment opportunity. This is especially true in established rural rental markets. Airbnbs in these areas commonly charge $200 or $300 a night and even more on weekends and holidays.
On the flip side, if you're looking at a beach house, and I know everyone wants a beach house, many of those homes are priced at $400 per square foot or way more, so they're not as profitable and would technically fail this Investability test. This is why we invest in rural Airbnbs, and advise our clients to do so as well if they're looking for maximum cash flow. You can absolutely make money at the beach. But because rental profit is baked into the sales prices of those homes, you typically won't get as much cash flow as a property in the mountains by a lake next to a winery or again with beautiful views.
So there you have it. Now you know how to analyze the profitability of a potential short-term rental before you buy it by using honest underwriting and one of the evaluation metrics or all that we discussed today, you could have cold, hard facts about the cash flow to inform your purchase decision.
If fear of buying the wrong property has kept you from investing, use facts to fight that fear. Start analyzing properties of interest around you and when you see numbers that equal significant cash flow, make an offer. This is how you build financial freedom. If you want help analyzing a potential investment book a free 30 minute call with us! We'd love to help you!
If you want to start Airbnb investing and simply need to know how to get started, that's what this podcast is for. Keep listening to the Host Coach Show. We're here every Tuesday to share our knowledge, tools, and investing strategies so you can get started and create your own financial freedom. Please share this episode as a resource with anyone you know who is interested in Airbnb investing. Our joy is in your success and theirs!