Perhaps the most important piece of your rental property strategy is calculating its ROI correctly. We stress the importance of doing it correctly because a single oversight could mean a massive headache later. This is especially true for anyone leasing or paying a mortgage.
The Variables Affecting Your ROI
Many a failed rental operation can point to poor financial projections as their undoing. Of course, this is true for any business – but the vacation rental industry is particularly tricky to predict. So, before we get to number-crunching, let’s just lay out the most volatile industry trends that you need to be aware of whilst planning.
If you’re already the owner of the property in question, pat yourself on the back and go to the next section.
Financing itself isn’t something that fluctuates once payments are being made, but there’s various forms of financing to consider. Each will present its own difficulties to overcome, so it’s up to you to investigate your options thoroughly.
You need to choose a financing strategy that’s right for you and your goals. You also need to choose one that’ll ensure your vacation rental business is sustaining itself after all initial investments are paid back.
Buy-to-Rent (or Buy-to-Let in the UK)
With real estate costs ever-rising, buy-to-rent schemes have become a popular choice for those interested in owning outright. This involves a mortgage whose payments will be factored into your costs. The risk of failure here is much greater than with a lease-to-rent scenario, but the reward for your success is a valuable piece of real estate.
Some people opt for personal loans to fund their property purchase due to no downpayment requirements. No. Just don’t do this. The interest rates are higher and payment terms are shorter. Obviously, there’s some exceptions where a creative financing strategy would work out, but in most cases you’d just be setting yourself up for failure. Please do some thorough reading before you dig yourself into a situation you can’t control.
As a rule of thumb, it’s best not to enter into a buy-to-rent strategy expecting to make a living while you’re paying a mortgage. All you should be looking to do is break even or pay your mortgage back quicker to get out of the red. You want to own that property outright as quickly as possible.
For more info on the various types of loans / mortgages that are commonly used for vacation rental purchases, read on here.
A lease strategy will reduce your investment and focus on monthly profits. If you have no interest in owning the property in question, this is where you want to be. The terms of your lease will be defined by your intent to sublet the property. You will likely be given a rent contingency based on your monthly revenue projections.
In the words of every archetypical on-screen slimy real estate agent ever: “location, location, location”. Your property’s location is a huge factor in whether or not your rental business plan is going to succeed.
With regular rental schemes, the value of your location is dependent on its most immediate surroundings. With vacation rentals, you have an extra factor to consider: tourist traffic.
Does this mean you can’t succeed with a vacation rental business in Iowa? Absolutely not. In fact, you may perform much better in Iowa than you would in New York simply because the real estate costs are so much better.
All it means is that you have to be realistic about your location’s rates and expected occupancy. This will help you accurately project how long you can expect to wait until you reach profitability.
To help you assess your location’s viability as a short-term rental property, we have a couple tools. First of all, do some independent research to make some general assumptions about your market. Are there hotels in the area? Are there tourist attractions in close proximity? Is there an airport? This is just common sense stuff, but it needs to be said.
Now let’s look at some numbers taken from a 2018 Rented.com report:
Top 10 Best Places to Buy Vacation Rental Property
|1||Panama City Beach||Florida||98.9||$26,301|
You’ll notice that rental income has very little to do with the score. That’s because the scores are based on ROI. New York appears at #143 on their list, in spite of massive tourism traffic and an average rental income of $68,505.
How can you avoid being sunk by real-estate costs? You need to seriously weigh the cost of your property against the average rates in your area. If you can’t sustain yourself on the average, your risk of failure is rising. You can use this tool to find out average Airbnb rates in your area.
OK, so this is a huge variable since it’s usually tied to seasonal traffic. The best way to handle this is to do your calculations with the objective of finding out what your lowest monthly occupancy rate would need to be. That way, you’ve got a goal to shoot for as well as a realistic plan.
If you’d like to find out what to expect instead of being safe, you’ll need to do some competitor research. All that means is utilizing Airbnb or another rental channel to find similar properties in your area. You’ll be able to view their availabilities to help you make some assumptions about your own property.
(Realistic) ROI Calculation
Now we come to the easy part – the math. With all of your variables taken into account already, it’s simply a matter of plugging the numbers into a formula. That formula, in its most basic form, looks like this:
Before you go get your calculator, try one of these tools first:
The LearnAirbnb calculator comes in the form of an Excel spreadsheet. It focuses on returning your initial investment and getting ahead of monthly lease costs. The Rented.com calculator gives individual income projections based on nightly, weekly, or monthly rates.