Short-Term Rentals: Apparently We Need to Talk About ROI

A Grackle’s Guide to Making Money While Strangers Sleep in Your House

I have been informed that owning a short-term rental is an investment.

This means we can't simply ask, “Did we make money?”

No.

Humans have developed an entire vocabulary specifically to make answering that question more difficult.

ROI. Cap rate. Cash flow. Occupancy. ADR.

I have learned these terms.

I do not respect them.

But if you're thinking about buying or operating a short-term rental, you should probably know what they mean.

So pull up a chair.

I'll be on the power line.

First, What Exactly Are We Doing Here?

A short-term rental—or STR, because apparently even “short-term rental” was too exhausting to say—is a house, apartment, condo, cabin, or other property rented to guests for relatively short stays.

Instead of having one tenant paying you every month, you have a parade of strangers staying for a few nights at a time.

They arrive.

They sleep.

They leave.

Someone discovers they cannot operate the television.

You send them instructions.

They do not read the instructions.

You send them again.

This is the business.

Platforms like Airbnb and Vrbo made this model enormously popular because travelers often want something hotels don't provide: kitchens, yards, multiple bedrooms, interesting neighborhoods, and enough room for an entire family to argue comfortably.

For property owners, the attraction is obvious.

Money.

Potentially more of it.

Let's Talk About ROI

ROI means Return on Investment.

This is investment-person language for:

“I put a bunch of money into this thing. Was that a terrible idea?”

The basic concept is simple.

If you invested $100,000 and the property generated $10,000 in profit, your ROI would be 10%.

Why we couldn't just say “I made ten grand on my hundred grand” remains unclear.

But ROI matters because a property generating lots of revenue isn't necessarily a good investment.

Revenue is all the money coming in.

Profit is what remains after everybody takes a bite out of it.

Mortgage.

Taxes.

Insurance.

Utilities.

Cleaning.

Repairs.

Management fees.

Platform fees.

Landscaping.

Supplies.

The plumber who charges $275 to inform you that someone flushed something that should never have entered a plumbing system.

That distinction is important.

Revenue is impressive at parties. Profit pays your mortgage.

Then There's Cash Flow

This one I actually understand.

Cash flow is basically the money left over after your property's expenses are paid.

Property brings in $8,000 this month.

Expenses are $6,000.

Congratulations.

You have $2,000 in positive cash flow.

If expenses are $9,000, you have negative cash flow.

That's investment terminology for:

Bad.

Humans will occasionally purchase properties with negative cash flow because they expect appreciation or future income growth.

Perhaps they're right.

I once fought another grackle for half a french fry in a parking lot, so I'm not qualified to criticize anyone's risk tolerance.

Occupancy Rate

Occupancy rate tells you how often your property is actually rented.

If your house was available for 30 nights and somebody rented it for 21 of them, you had 70% occupancy.

Simple.

But here's where people get themselves into trouble.

Higher occupancy isn't automatically better.

If you drop your price to $49 a night, you might achieve fantastic occupancy.

You might also achieve bankruptcy.

Which brings us to another acronym.

ADR

Average Daily Rate.

ADR tells you the average nightly rate guests actually paid.

If you booked 10 nights and collected $3,000 in room revenue:

Your ADR was $300.

Again, I don't know why we needed an acronym.

But we have one.

The trick is balancing ADR and occupancy.

You don't necessarily want the highest possible nightly rate.

You don't necessarily want the highest possible occupancy.

You want the combination that generates the best return.

This is called revenue management, which sounds considerably more sophisticated than:

Charge more when people really want the house.

Location Still Matters

You have probably heard the phrase:

Location. Location. Location.

Real-estate people say this constantly.

Annoyingly, they're right.

A beautiful house nobody wants to visit is going to have a difficult time as a vacation rental.

You need to understand why guests would stay there.

In Austin that might mean proximity to downtown, restaurants, nightlife, festivals, universities, wedding venues, parks, swimming holes, major employers, or neighborhoods people actually want to experience.

But don't simply assume:

Austin + House = Airbnb Gold Mine.

Look at comparable properties.

What do they charge?

How often are they booked?

What amenities do they offer?

How many bedrooms?

Pools?

Parking?

Walkability?

Are you competing against ordinary houses or places with rooftop decks, heated pools, fire pits, and enough neon signs to illuminate a municipal airport?

Know your competition.

Now We Need to Discuss Cap Rate

I was hoping we wouldn't.

Capitalization rate, or cap rate, is a way investors compare the income-producing potential of properties.

Very roughly:

Annual Net Operating Income ÷ Property Value = Cap Rate

So if a $500,000 property produces $40,000 per year in net operating income:

$40,000 ÷ $500,000 = 8% cap rate.

There are rules about which expenses are included in Net Operating Income, and notably your mortgage generally isn't one of them.

Why?

Because cap rate is intended to evaluate the performance of the property itself, independent of how you financed it.

That actually makes sense.

I resent that.

Cap rate can be useful when comparing investments, but short-term rentals have enough fluctuating income and operating expenses that you shouldn't rely on this number alone.

Your Mortgage Changes Everything

Two people can buy identical houses and have completely different returns.

One pays cash.

One finances 80%.

Their houses perform identically.

Their personal investment returns do not.

This is where something called cash-on-cash return becomes useful.

It basically asks:

How much cash did I actually put into this thing, and how much cash did it produce for me?

If you invested $100,000 of your own money into purchasing and setting up the property and it produces $12,000 in annual cash flow:

Your cash-on-cash return is roughly 12%.

I find this considerably more understandable than cap rate.

I still don't like it.

Don't Forget the Cost of Making the Place Nice

Short-term rentals aren't normal rental properties.

You're not just buying the building.

You're creating the product.

Beds.

Mattresses.

Furniture.

Linens.

Kitchen equipment.

Televisions.

Outdoor furniture.

Decor.

Locks.

Wi-Fi equipment.

Coffee makers.

Hair dryers.

Approximately 47 throw pillows.

All of that initial setup money is part of your investment.

And cheaping out isn't always smart.

Guests are buying an experience.

A well-designed property photographs better.

Better photographs generate clicks.

Clicks generate bookings.

Bookings generate money.

Money can be exchanged for tacos.

We have now reached the portion of investment theory that I fully understand.

Property Management Costs Money Because Property Management Is Work

You can manage an STR yourself.

Many owners do.

This saves management fees.

It also means you are the management company.

Guest messages.

Scheduling cleaners.

Maintenance.

Pricing.

Reviews.

Supplies.

Check-ins.

Check-outs.

The mysterious disappearance of bath towels.

The guest who messages you at 11:43 p.m.:

“How do I turn on the hot tub?”

This is why professional property management costs money.

When analyzing an investment, don't pretend management is free simply because you're doing it yourself.

Your time has value.

Even mine does, and I spend several hours a day screaming from a telephone pole.

Reviews Are Money

This sounds ridiculous.

It is also true.

Good reviews can improve booking performance.

And good reviews generally come from remarkably boring things:

The house was clean.

The beds were comfortable.

The photos were accurate.

Everything worked.

Check-in was easy.

The host answered questions.

Nobody discovered a colony of ants occupying the toaster.

You can spend $15,000 installing an elaborate outdoor kitchen and still get a mediocre review because there were only three bath towels.

Hospitality is cruel that way.

Dynamic Pricing

Here's another impressive-sounding term.

Dynamic pricing means changing your nightly rate based on demand.

Weekend?

Price changes.

Festival?

Price changes.

Holiday?

Price changes.

Tuesday in February when absolutely nothing is happening?

Price changes.

Hotels and airlines have been doing this forever.

There are software tools that automate much of it, or you can manage pricing yourself.

Either way, the idea is simple:

Not every night is worth the same amount of money.

If 100,000 people suddenly descend on Austin for an event and you haven't adjusted your rates, congratulations.

Someone just got a fantastic deal on your house.

Regulations: The Part Where the City Gets Involved

Before buying a property specifically for short-term rental use, understand the local regulations.

This is particularly important in Austin.

Short-term rentals can be subject to licensing requirements, zoning restrictions, occupancy rules, taxes, and other regulations that can significantly affect whether your investment plan works.

Do this research before you buy the property.

Not afterward.

Not during renovation.

Not when you've already purchased eight queen mattresses.

Before.

A spreadsheet projecting enormous STR revenue is useless if you're not legally allowed to operate the property the way you planned.

I don't have this problem.

No governmental agency has yet successfully regulated where I sleep.

Insurance

Your normal homeowner's insurance policy may not adequately cover commercial short-term rental activity.

So talk to an insurance professional who understands STRs.

You'll want to understand coverage for things like property damage, liability, lost rental income, and whatever happens when twelve adults arrive for what was described in the reservation as a “quiet family weekend.”

Do not assume you're covered.

Insurance companies are notoriously particular about this.

So Is a Short-Term Rental a Good Investment?

Maybe.

That's the irritating answer.

A successful short-term rental can generate considerably more gross income than the same property operated as a traditional long-term rental.

But it can also have considerably higher expenses and require much more work.

That's why you need to look beyond the giant revenue number.

Look at:

• Revenue: How much money comes in?

• Operating expenses: How much does it cost to run?

• Cash flow: What's actually left?

• Occupancy: How often does it book?

• ADR: What are guests paying per booked night?

• ROI: Was putting your money into this property worthwhile?

• Cash-on-cash return: How well is the actual cash you invested performing?

• Cap rate: Something about dividing numbers until an investor nods approvingly.

Run conservative numbers.

Assume things will break.

Budget for replacements.

Don't assume every weekend will book.

Don't base your entire financial future on what one house down the street charged during SXSW.

And remember:

Buying a house and operating a hospitality business are two different things.

A short-term rental requires you to do both.

Do it well, and you've got an interesting property generating real income.

Do it poorly, and you've purchased yourself a very expensive second job.

Either way, I'll be outside.

Watching.

Judging.

Waiting for someone to drop a french fry.

— The Grackle