How to Calculate ROI for an Airbnb Short Term Rental Property
JG - September 20, 2021
Are you getting into short term rental (STR) investing, specifically, looking to purchase an Airbnb property? Whether you’re looking to make some extra cash flow or looking to increase your net worth using real estate appreciation, it is important to know how to analyze a property purchase for STR investing. Quick disclaimer: This may get a little math-y and also, this is not any type of investment or financial advice (see our ToS). This is just how I think about purchasing a property for Airbnb and assessing the theoretical return on investment (ROI).
If you don't want to read, there's a YouTube version of this video at the end of this post that goes through another case study for a property on Zillow.
Determining the Airbnb’s Revenue Potential
Ideally, a good investment doesn’t lose money on cash flow. Basically what that means is the total revenue from your Airbnb covers all expenses and more. Your revenue collected from Airbnb are all the rents and cleaning fees.
In order to estimate your Airbnb revenue, either on a monthly or annual basis, there are a few things to keep in mind:
- The nightly rate charged to your guests. This can be estimated by getting a feel for the Airbnb listings in the marketplace. You can search for listings that are similar in size to a property that you want to purchase. This means looking at listings with a similar amount of beds, baths, types of amenities, location, etc. to the property you are looking to purchase.
- Occupancy rate. The occupancy rate is the “number of nights booked divided by total nights available to be booked” in a specific time frame. For example, if you have every night booked for a month, your occupancy rate is 100% for that month. Similarly, if you have half of the nights booked your occupancy rate is 50%. This parameter is harder to estimate since these numbers are really available to the public. You can ask other Airbnb landlords in your area or you can just assume something conservative like 30-50%.
- Cleaning fee charged to your guests. This is a smaller aspect of your revenue but Airbnb allows you to charge your guests a cleaning fee to cover the costs of cleaning during a turnover. Estimating this is also a bit tricky but you can call around to Airbnb cleaning services and ask how much they charge or search Airbnb’s listings and kind of get the average price of cleaning fees for properties similar to yours.
- Finally, the average number of bookings for the time frame you are looking at. For example, Airbnbs of this size in this area typically have 3 bookings per month. This is difficult to estimate as well but only really comes into play when estimating your revenue from the cleaning fee. If you want to be conservative in your analysis, you can just omit counting the cleaning fee as revenue.
Using these 4 parameters, you can estimate a total monthly (or annual) revenue like so:
Alright, now you can calculate how much your Airbnb may potentially bring in. Next, time to estimate the expenses.
Estimating Expenses
From an expense standpoint, an Airbnb property is just like a regular long term rental property where the tenant signs a lease except for a few things:
- Airbnb takes a commission for each booking you land as a fee for using their platform and marketplace. That fee is currently 3% of your total revenue.
- Cleaning costs are recurring due to frequent guest turnover.
- Any extra insurance you want for Airbnb business.
- Internet, entertainment subscriptions (like Netflix), etc.
- Utilities (water and electricity)
Some other common expenses that should be accounted for when operating a real estate investing business include (but are not limited to):
- Mortgage payments
- Property taxes
- Routine maintenance and repairs (i.e. lawn care, pool, plumbing, etc)
- Large one time purchases AKA CapEx (roof replacement, AC replacement, etc)
- Any insurance
It’s a good idea to at least try to estimate all of these expenses and do so conservatively so that there are no surprises when you begin operating the Airbnb. All these numbers can be summed to determine the total expenses.
Calculating the Airbnb Total Cash Flow
Let’s look at an example with monthly numbers from the revenue section and expenses above. I understand that some of these expenses can’t be broken down to monthly numbers and some, like a roof replacement, won’t happen very often but we’ll try to account for them anyways. And obviously, these are all fictitious numbers.
Calculating the cash flow in this example is done by subtracting the expenses from the revenue which results in a monthly cash flow of $1,353 and an annual cash flow of $16,236. Not bad.
In this scenario, you’re making some assumptions and essentially running an experiment on a property that you might want to purchase. The analysis turned out with positive cash flow and that’s good. But it could’ve just as easily turned out negative when say, for example, you can only purchase with a small down payment and your mortgage cost balloons to something large. Or the supply of Airbnbs in the area is too high and you can’t make enough rental revenue. The scenarios are endless but performing this cash flow analysis can tell you if it’s still a good idea to purchase this property for Airbnb.
Return On Investment
Another factor in purchasing an Airbnb property is what the return on investment is. Well, technically cash on cash return. Cash on cash return is a measure of how much cash you’re getting compared to your initial investment in the property and is represented as a percentage.
If your property generates a lot of cash and it took you very little initial investment, that’s a great cash on cash return. If it only generates a little bit of cash but it took a lot of initial investment, then it’s not a great return.
This cash on cash return can be used to compare to other investment yields like stock dividends. For example, the SP500 index dividend yield is currently ~1.3%. You can either buy an Airbnb property that has a cash on cash return of 1.3% or just buy the SP500 index. That’s the same thing right? Well, not really. There are a lot of factors in coming to a decision. For example, buying the index fund is completely passive whereas running an Airbnb is not. So, seeing as the Airbnb property is not passive, I would want a higher cash on cash return than the SP500 index fund.
Also, the underlying assets, in this case the SP500 fund and the Airbnb property may appreciate or depreciate and may do so differently. This is more in line with the technical definition of ROI. You can try to estimate this when purchasing an Airbnb property but it changes with location, government, regulation, etc. and is very hard to predict.
So determining your theoretical cash on cash return can also help you figure out if it's worth it to purchase the property as well as use that number to compare with other properties. How can you calculate the cash on cash return though? Well, I detailed a method to determine the total annual cash flow above. All that’s left to estimate is the initial total cash investment.
From the initial investment standpoint, here are some things to consider when purchasing an Airbnb property:
- Cost of initial repairs. Are you buying a fixer upper? Be ready to estimate all repair costs and then add some buffer.
- Cost of furnishing the property.
- Down payment
- Cost of Closing fees and other purchasing costs like tax and insurance
- Any assessments or inspection costs
- Any mortgage, utilities, etc. payments during the time you are getting the property ready to be lived in
You can just sum all these costs up to determine the initial total cash investment. Then, just plug that number into the equation and you can calculate the estimated cash on cash return. For example, continuing with the previous scenario and usually fictitious numbers:
Now, this $124,500 initial total cash investment can be plugged into the cash on cash return formula with the annual cash flow as $16,236.
Performing the calculation, this results in a 13% cash on cash return.
There is another metric some people use to quickly assess STR investments and it is called the cap rate metric. I like to use cash on cash returns because I feel it captures more information and tells more about the bigger picture.
Check out the YouTube version of this post:
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Check out the Z Real Estate Calculator here!
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Takeaways
The numbers always have to make sense when purchasing an Airbnb property. Otherwise, you may be buying a bad investment that’s not worth your time. Be sure to conservatively estimate things and to list all sources of income and expense. This is how I go about assessing Airbnb properties. Hopefully, this article has provided some insight on how to calculate the return on investment, specifically the cash-on-cash return when purchasing an Airbnb rental property.
Read more about cash on cash return here. Read more about ROI and IRR here.
Disclaimer: BNB Toolbox does not provide tax, business, legal, investment, or accounting advice. This material has been prepared for educational purposes only, and is not intended to provide, and should not be relied on for, tax, business, legal, investment, or accounting advice. You should consult your own tax, business, legal, investment, and accounting advisors before engaging in any transaction. Using this website means you've read and agreed to our Terms of Service.