In simple terms, underwriting assesses the viability of an investment decision by taking a deeper look into the financials to determine potential returns.
Throughout the process, you should be working through a number of different models to take most of the guesswork out of your revenue prediction. Using the wealth of data that’s available and analyzing it for patterns, trends, and outcomes, you can be very close to accurate in predicting a multi-tiered performance production regarding your monthly income and cash flow.
Those should be the first knowns in the underwriting process.
From there, it’s important to predict the upfront costs associated with the purchase and the equity that can be leveraged as part of the equation. Those two factors will greatly influence the early financial beginnings.
On the same balance sheet should be the predicted gross yield, cash-on-cash return expectations, capitalization rate, and internal rate of return (IRR).
With these factors all taken into consideration, you’re beginning to establish a realistic picture of the risk and the return involved in your short-term rental venture, and that can inform your approach to borrowing, underwriting, and negotiating.
Keep Your Comps Close
Experienced hosts will be familiar with the use of comps in setting valuations. Comps — or comparables — are similar assets that have recently been sold. Their sale can presumably inform the valuation of the similar asset in question.
A recent list of home prices at the point of sale for comparable properties normally informs the value of a home and the line of equity that can be taken out against it.
Short-term rentals are again unique in that when you do their due diligence, comparable properties can inform more than the property’s sale price.
The need to analyze the property’s performance with real-time market data gleaned from similar properties in the surrounding area was touched on earlier. But getting specific and accurate data on the comps at the underwriting stage is valuable. Estimates should be kept conservative, and you should pause here to ensure your model still fits.
Check for Red Tape
Rules and regulations change quickly in the short-term rental space, and there’s nothing like an unexpected dead end to turn a real estate investment upside down. It’s crucial at the final stage of analysis that you search high and low for any regulation or litigation you might’ve missed, especially if you’re operating in new market areas.
Homeowner associations (HOAs), neighborhood laws, and city bylaws change across an invisible grid. There are town and municipality restrictions to take into consideration, and there are county restrictions that might not be common knowledge.
You should not only do a thorough search for laws and regulations in your market, but you should also reach out to that community of experienced hosts to see if any of their peers have experience in your specific location.
Ask for Quotes
Part of a complete analysis and underwriting model is acquiring the quote for the full-scale property management. This is a priority whether or not you plan to self-manage the property.
In the short-term rental space, many proposals include the underwriting, the revenue estimates, and the expected cost of management as part of the proposed offer. It’s to everyone’s benefit that this part of the equation is as accurate as it can be.
Engaging with a property manager to establish an initial quote, or learning from other hands-on hosts about the costs they encountered, will help ensure this fundamental part of the financial model doesn’t go overlooked.
Leave Emotions Behind
This is the stage at which the water can get choppy. The numbers can get big, loaners can misunderstand the short-term potential, and no can be a word that’s hard to hear. But some of the household name lenders have recently made waves in understanding short-term rentals as the business opportunities — not the personal assets — that they really are.
All signs point toward more support and understanding ahead. It’s important that you leave your emotions at the door and commit to making the numbers make sense. When the deal is right, nothing will stop it from finalizing.
One Last Gut Check
With the end in sight, it’s time to return to the beginning. The first exercise outlined in this chapter had nothing to do with the optimal market positioning, the math behind a great investment, or the optimal strategy for property management. It simply asked you to begin with an image of what wealth would mean to you.
The short-term rental market is the kind of boom that comes around, if they’re lucky, once in a host’s career. The market continues to support the Airbnb model with no signs of slowing down, and the personal and financial freedom the venture can bring is unparalleled.
As the housing market climbs further out of reach for many Americans, short-term rentals are a hopeful and necessary strategy to regain some financial security and portfolio diversity.
But none of that means much if the strategy has strayed from your initial intentions.
Take this moment as an invitation to return to that vision of wealth. Are you traveling? Are you sitting on a 50+ property portfolio? Most importantly, does this property model you’ve arrived at set you up in that direction?
If the answer is yes, you have the green light — sign the dotted line and let the short-term rental fun begin.