Determining which property to buy can only happen when you understand how to properly project rent and expenses for that property.
Analyzing potential income for an investment property can seem like a daunting task. Having gone through the process several times myself, I had a lot of anxiety trying to figure it out. Which tools could I trust to provide reliable rent projections? How did I know what expenses I should budget for? Was there already a high supply of rentals in the area I was looking at?
While investing will always come with risks, it is important to take a systematic approach to analyzing the numbers to makes sure your excitement doesn't get the best of you when you see a beautiful potential property.
Projecting the potential income of a property doesn't have to be difficult. It is simply about having a reliable source to approximate revenue, a realistic accounting of total expenses, and a viewpoint on whether that income is likely to continue across your investment horizon (i.e. how long you want to hold the property).
We'll go through a quick breakdown of the three areas you will need to get comfortable with to accurately project income: revenue (i.e. rent from the unit), expenses (including the non-obvious expenses), and how to tell if the market you are looking at is already saturated with competitors, or whether there is enough cake to go around for new investors.
Start By Calculating Revenue
The first thing that you will want to look at when analyzing a property is the potential top-line revenue (i.e. income from AirBnB/VRBO/etc.) your property is likely to generate. There are few sources that are very helpful in projecting this revenue, but they are all based on understanding the basic concepts, of average daily rate (ADR) and occupancy %.
The average daily rate is the average rental rate per day of your target property. While some properties are located in areas with high seasonality (e.g. Lake Tahoe, CA) where you will see high ADRs in the summer and winter months, it is best to understand what your ADR is by season (in addition to looking at an overall average ADR for the year). This will allow you to get a better understanding of the potential cash flow fluctuations you might experience for across those seasonal months.
In addition to ADR, you also need to determine the occupancy (i.e. % of time that is occupied by a paying guest) of your target property. While there is no universal definition for "good occupancy" (although we can all agree that we would love 100% occupancy), it is important to look at the average occupancy for your target property and compare it to the city/neighborhood in which other similar properties project.
1. Use Online Rent Analyzers To Project Revenue
Luckily for us there are several great free resources out there that help to provide a starting point on projecting revenue. AirDNA has a property rentalizer feature that allows you to drop in the address of a specific property and have it return a projected monthly income for you.
Data Rabbu is another site that projects revenue, and also includes links to specific AirBnB comparable listings so that you can verify actual rates and calendar occupancy of those comparable listings directly on AirBnB. Both AirDNA and Data Rabbu are free tools and incredibly powerful in providing you a first pass at projecting monthly income for a target property.
2. Look At AirBnB And VRBO Specific Listings
If the property you are looking to buy is currently being listed on AirBnB or VRBO, go straight to those listings on AirBnB or VRBO to find the specific listing. Some owners may remove the AirBnB listing once they list their property for sale, but many still leave them up (at least until they go into escrow). I love reading through reviews of the current listing to get a better understanding of property specific nuances (e.g. do guest reviews complain of road noise, does the house get abnormally hot even with air conditioning, how is the neighborhood, etc.). These nuances are not always evident on the Zillow listing of the house but you can catch potential red flags in reading through customer reviews on AirBnB or VRBO.
You should also look at homes nearby your target property on AirBnB to see their ADR and occupancy rates. I have also found it very useful to see how neighboring properties are marketing their properties on AirBnB. For example, are they catering more towards families with small kids, couples looking to go on a romantic getaway, or business travelers? As you explore new markets that are not in your own city, seeing how other existing comparable properties are being marketed on AirBnB will give you a good idea of how you might want to list your property (or if you want to be different, what will you need to change). If you are looking to buy a condo in a particular building, looking at other listings within the building also gives you a strong sense of the vibe of the property (e.g. Grade A vs. Grade B building).
3. Look At Historical Rental Data From Your Specific Property
When you get serious about purchasing a property and are about to make an offer, it is common to ask the listing real estate agent for historical rental rates and occupancy for the property you are interested in. While it is not required for sellers to provide this information, many of them do voluntarily, which allows you to see real actual income generated in the past from the property.
However, there are some caveats to remember when looking at actual data. First, historical rates are not always indicative of future rates as they could have been subject to abnormal events. Anyone looking at rental rates from 2020-2021 will obviously see major fluctuations in occupancy rates due to COVID. Make sure to have context on why rates were lower or higher in previous years to make an appropriate assessment of where you think rental rates will be going forward.
Second, there are a lot of AirBnB properties that are managed by property managers who are more concerned with keeping a high occupancy, at the expense of lower average daily rates. In other words, underpricing happens a lot in the market, so there is still opportunity to make more money than what the historical financials might say about a property.
Calculate All Major Expenses
After you have a good grasp on the monthly potential revenue from a property, you will have to add up all the monthly expenses. While some real estate agents may provide a "cost to own" worksheet to summarize these costs, it is good to understand the major types of expenses for all properties.
Mortgage: If you are financing your property you will need to account for your monthly mortgage payment (principal + interest).
Property tax: Regardless of how you decide to pay for the purchase of your property, you will be responsible for property tax, which typically ranges from 1-2% of the total home purchase price.
Insurance: Homeowners insurance for rental properties is required by lenders if you are financing your home (and a good idea even if you are buying with all cash). The specific types of homeowners insurance required will depend on the specific risks in your area. For example, additional flood insurance might be required in areas that are prone to flood or hurricane insurance for areas that are prone to hurricanes.
HOA fees: Monthly home owners association fees can sometimes be over $1,000 in popular AirBnB beach locations such as Hawaii, or very low in more residential areas like Palm Springs, CA. HOA fees are correlated to the amount of community amenities your property has access to (e.g. community swimming pools, gyms, parks, playgrounds). The more amenities, the higher the HOA fees will be.
Utilities: Electricity in particular can be a significant cost in beach and snow locations that are popular for vacation rentals. Imagine heating a hot tub in Park City or running the air conditioning in a South Florida beach home for many hours a day. It is important to get an estimate of what the monthly electricity costs (and other utilities) are for your property, since unlike long-term rentals, these costs are generally the AirBnB owner's responsibility.
Property Management: If you do not want to manage the day to day operations (e.g. getting new bookings, coordinating with cleaners, guest communications, billing issues, etc.), you should factor in the cost of hiring a property management company to help you. The fees for a property manager vary but most full service property managers will charge a fee of 20-25% of monthly revenue. There are also some non-full service property managers that charge lower fees. For example, when I started with my first AirBnB property, I was using a property manager that only handled the online bookings, but did not handle coordinating with the cleaning crew (I still had to do that separately). They only charged 10% for that limited service as opposed to the normal 20-25% for a full service property manager.
Maintenance: Things will inevitably break and wear down in your unit. Broken coffee machines and sink repairs are all part of renting out your AirBnB. There are many wear and tear items that break where you can not point to one specific guest, and those are costs that over time need to be accounted for in your projections. For items that guests break specifically, AirBnB, VRBO, and other booking platforms usually offer some damage protection in addition to possibly being covered by your homeowners insurance policy.
Calculate Total Net Income
Now that you have your monthly revenue and your monthly expenses, simply subtract one from the other to arrive at your monthly net income from your property. This is the cash flow that you can expect to generate on your property on average each month. You should use this projected net income as a way to compare similar properties in the same city.
Evaluate The Forward Looking Demand And Supply
When you use tools like AirDNA's rentalizer to project monthly revenue, there is an implicit assumption about the viability of that property as an AirBnB destination going forward. However, you must remember that those projections are based on the recent performance of the property, more so than what the longer term future performance is going to be. In other words, just because a city like Palm Springs has been a great performing AirBnB destination over the last five years, it does not mean that a house in Palm Springs will be a great performer over the next five years.
One sanity check that I like to do to try to determine how strong the overall demand is of a market is to look at trends in visitor growth for an area. For example, when looking at visitors to the various Hawaiian islands in the past few years, you can see that there is still upside for visitors to return to pre-COVID levels. From the graph below, you can see that visitors are continuing to trend upwards in 2022, but are still ~20% lower than they were in 2020 or 2019. This signals to me that there is additional upside in the current market demand, which is a good thing for someone buying a property in Hawaii right now.
Similarly on the supply side of the equation, it is good to sanity check how much total competition is out there in the current marketplace. One way to get an idea of how many total listings are in your target area is to check AirDNA, which can give you an exact number of listings on AirBnB and VRBO for a particular area. However, knowing that there are 7,371 listings in Austin is not that helpful unless you can get a sense of how much of that supply is occupied by guests. That is why I like to go directly onto AirBnB, put in some dates in the near future (e.g. one week from today), and see how many available listings populate. If the number is 300+ (the default indicator on AirBnB when there are over 300 available listings), then that could be a sign that there are lots of available options. If there are less than 300 available, it usually indicates an extremely high demand market.
To be clear, I don't automatically rule out areas just because AirBnB shows there are 300+ units available, as there could still be plenty of demand to consume that inventory. It is more of a litmus test for extremely hot markets, particularly ones that are requiring heavy bidding wars in order to win a property. If I'm going to have to beat out 5 other bidders in purchasing a property, I generally like to make sure that guests are also having a tough time finding inventory too on AirBnB in that market, a validation of the inherent demand and limited supply.
The Bottom Line
Going through the process of projecting revenue, projecting expenses, and sanity checking overall supply and demand of a market are must-dos before purchasing an AirBnB. There are plenty of great free resources mentioned above to help you refine your projections to arrive at an estimate you can be comfortable with. Remember, projecting income is not always an exact science, but you should try to look at validating your projections from a few different sources. At the end of the day, you should have conviction on the long term viability of where you are investing, because rental properties are not like stocks that you can just sell quickly. Plan on being a long term investor and do the proper due diligence before buying your vacation rental in 2023.
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