Short term rental properties, such as those listed on Airbnb, have become a popular investment option in recent years. However, as with any investment, it is essential to analyze the potential return on investment (ROI) to make an informed decision. In this article, we will provide a step-by-step guide to help you analyze the potential ROI of a short term rental property.

Step 1: Determine Your Investment Goals

Before diving into the metrics, it is crucial to determine your investment goals. Are you looking for a high ROI or steady cash flow over time? Your investment goals will influence the metrics to focus on when analyzing the potential ROI of a short term rental property. According to Kwan and Yan (2019), investors must also consider their risk tolerance and investment horizon when setting their investment goals.

Step 2: Estimate Your Revenue Potential

The next step is to estimate your revenue potential. This involves researching the rental rates for similar properties in the area and calculating the expected occupancy rate. Online tools, such as AirDNA, can also help investors get a more accurate estimate of potential revenue. However, it is essential to note that these tools are only estimates and should not be relied upon solely. As AirDNA (2021) notes, investors must also consider factors such as seasonality and local events that can impact revenue potential.

Step 3: Calculate Your Operating Expenses

The next step is to calculate your operating expenses. This includes expenses such as property taxes, insurance, utilities, cleaning fees, and maintenance costs. As AirDNA (2021) notes, investors must include all expenses associated with owning and operating the short term rental property to get an accurate estimate. It is also essential to consider any ongoing expenses, such as regular maintenance and repairs.

Step 4: Determine Your Cash Flow

Once you have estimated your revenue potential and calculated your operating expenses, you can determine your cash flow. Cash flow is the amount of money left over after paying all of your operating expenses. A positive cash flow is essential for a profitable short term rental investment. As Lohmann et al. (2019) note, investors must also consider their financing costs, such as mortgage payments, when calculating cash flow.

Step 5: Calculate Your Return on Investment (ROI)

The final step is to calculate your ROI. To do this, divide your annual cash flow by your total investment in the property (including the down payment, closing costs, and any renovation costs). Multiply this number by 100 to get your ROI percentage. As Kwan and Yan (2019) note, investors must factor in the time value of money and the risk associated with short term rental investments when calculating the ROI. It is also essential to consider any potential capital gains or losses when selling the property in the future.

In summary, analyzing the potential ROI of a short term rental property involves determining your investment goals, estimating your revenue potential, calculating your operating expenses, determining your cash flow, and calculating your ROI. By following this step-by-step guide, investors can make an informed decision about whether or not to invest in a short term rental property.

Investing in short term rental properties can be a viable investment option, but it requires careful analysis and consideration of the key metrics. As Kwan and Yan (2019) note, investors must also stay up-to-date with industry trends and regulations to maximize their ROI and minimize their risk. By conducting thorough research and analysis, investors can identify short term rental properties that offer the potential for long-term profitability and success.

Now that you have a better understanding of the key steps involved in analyzing the potential ROI of a short term rental property, let's take a closer look at some of the metrics involved.

Revenue Potential

Estimating your revenue potential is one of the most critical steps in analyzing the potential ROI of a short term rental property. One of the best ways to do this is to research the rental rates for similar properties in the area. Look for properties that are similar in size, location, and amenities to get an accurate estimate of potential rental income.

You can also use online tools such as AirDNA to get a more accurate estimate of potential revenue. AirDNA uses a sophisticated algorithm to analyze market data and provide insights into potential revenue, occupancy rates, and other key metrics. However, it is essential to note that these tools are only estimates, and you should also do your research and factor in other factors that can impact revenue potential, such as seasonality and local events.

Operating Expenses

Calculating your operating expenses is another crucial step in analyzing the potential ROI of a short term rental property. Some of the most common expenses associated with owning and operating a short term rental property include property taxes, insurance, utilities, cleaning fees, and maintenance costs.

To get an accurate estimate of your operating expenses, you should factor in all of the costs associated with owning and operating the property. This includes ongoing expenses such as regular maintenance and repairs. It is also essential to factor in any financing costs, such as mortgage payments, when calculating your operating expenses.

Cash Flow

Once you have estimated your revenue potential and calculated your operating expenses, you can determine your cash flow. Cash flow is the amount of money left over after paying all of your operating expenses. A positive cash flow is essential for a profitable short term rental investment.

To calculate your cash flow, subtract your operating expenses from your revenue potential. This will give you an estimate of the amount of money you can expect to have left over each month after paying all of your operating expenses.

Return on Investment (ROI)

Calculating your ROI is the final step in analyzing the potential ROI of a short term rental property. To calculate your ROI, divide your annual cash flow by your total investment in the property (including the down payment, closing costs, and any renovation costs). Multiply this number by 100 to get your ROI percentage.

It is essential to factor in the time value of money and the risk associated with short term rental investments when calculating your ROI. It is also essential to consider any potential capital gains or losses when selling the property in the future.

In conclusion, analyzing the potential ROI of a short term rental property is a critical step in making an informed investment decision. By following the steps outlined in this article and doing your research, you can identify short term rental properties that offer the potential for long-term profitability and success. However, it is essential to factor in the time value of money and the risks associated with short term rental investments when making your calculations and to consult with a financial advisor or real estate professional before making any investment decisions.

One additional factor to consider when analyzing the potential ROI of a short term rental property is the impact of investor sophistication on investment strategies and returns. A study by Kwan and Yan (2019) found that investors with higher levels of financial sophistication were more likely to invest in a diversified portfolio of real estate crowdfunding projects, resulting in higher returns than those who invested in a smaller number of projects with higher risk.

Another important consideration when analyzing the potential ROI of a short term rental property is its performance compared to other investment options. A study by Lohmann, Wendt, and Westerheide (2019) found that short term rental investments can provide higher returns than traditional long-term rental properties, but also carry higher risks due to their dependence on short-term market trends and seasonality.

In addition to these factors, it is important to stay up-to-date with industry trends and regulations that may impact the profitability of short term rental investments. For example, changes in local zoning laws or regulations may impact your ability to operate a short term rental property in certain areas.

Overall, analyzing the potential ROI of a short term rental property requires a comprehensive approach that takes into account a variety of factors, including revenue potential, operating expenses, cash flow, ROI, investor sophistication, and industry trends and regulations. By doing your research, consulting with professionals, and staying informed, you can make informed investment decisions and build a successful short term rental portfolio.

References:

AirDNA. (2021). Maximizing Returns on Short-Term Rentals: A Comprehensive Guide.

Kwan, C., & Yan, S. (2019). Real Estate Crowdfunding: The Impact of Investor Sophistication on Investment Strategies and Returns. Journal of Real Estate Research, 41(1), 1-34. doi: 10.1080/10835547.2017.1394668

Lohmann, G., Wendt, O., & Westerheide, P. (2019). The Performance of Short-Term Rental Investments. Journal of Real Estate Literature, 27(1), 47-63. doi: 10.1080/09296174.2019.1553052

Now that you have a better understanding of the key steps involved in analyzing the potential ROI of a short term rental property, let's take a closer look at some of the metrics involved.