Underwriting a Short-Term Rental Property

Underwriting a short-term rental is fundamentally different from analyzing a traditional rental property. Variable income, higher operating costs, regulatory risk, and market-specific dynamics require a specialized approach to project returns accurately.

This guide provides a comprehensive framework for underwriting short-term rental properties, applicable whether you're evaluating a new acquisition or assessing an operating property.

Table of Contents

1. Quick Summary
2. The STR Underwriting Framework
3. Revenue Projection Methods
4. Operating Expense Analysis
5. Key Investment Metrics
6. Risk Assessment
7. How This Affects Investors
8. How This Affects Operators and Sellers
9. STR Underwriting Template
10. Worked Example: Complete Underwrite
11. Common Mistakes to Avoid
12. FAQ

Quick Summary

• Use multiple revenue sources for projections—AirDNA, comparable listings, and actual data if available
• STR operating expenses run 35-50% of revenue—significantly higher than long-term rentals
• Conservative occupancy (65-75%) and ADR projections prevent overpaying for optimistic scenarios
• Regulatory risk requires explicit assessment—a property isn't worth much if STR becomes illegal
• Cap rate and cash-on-cash are key metrics, but understand their limitations for variable income

The STR Underwriting Framework

Overview of the Process

STR underwriting follows this sequence:

1. Revenue Projection
   ├── ADR (Average Daily Rate)
   ├── Occupancy Rate
   └── Gross Booking Revenue

2. Operating Expenses
   ├── Variable (cleaning, supplies, commissions)
   ├── Fixed (mortgage, insurance, utilities base)
   └── Reserves (repairs, replacement, vacancy)

3. Net Operating Income
   └── Revenue - Operating Expenses

4. Investment Metrics
   ├── Cap Rate
   ├── Cash-on-Cash Return
   ├── DSCR (Debt Service Coverage)
   └── IRR (if projecting long-term)

5. Risk Assessment
   ├── Regulatory
   ├── Market
   └── Operational

Data Sources for Underwriting

Conservative vs. Aggressive Assumptions

Conservative (Use for Purchase Decision):

• Occupancy: Market average or below
• ADR: Market average
• Expenses: Higher end of range
• Growth: 0-2% annually

Moderate (Base Case):

• Occupancy: Market average + 5%
• ADR: Slight premium for good listing
• Expenses: Industry average
• Growth: 2-3% annually

Aggressive (Upside Scenario Only):

• Occupancy: Top performer levels
• ADR: Premium for optimized listing
• Expenses: Optimized operations
• Growth: Market growth rate

Rule: Never pay based on aggressive projections.

Revenue Projection Methods

Method 1: Market Data Approach

Use market data tools to estimate:

MARKET DATA PROJECTION

AirDNA Data for [Market, Property Type]:
- Median ADR: $185
- Median Occupancy: 62%
- Revenue Potential (90th percentile): $58,000

Conservative Adjustment:
- Assume 75% of median = new listing/learning curve
- ADR: $185 × 0.90 = $167
- Occupancy: 62% × 0.85 = 53%

Projected Annual Revenue:
- Available nights: 365
- Booked nights: 365 × 53% = 193
- Revenue: 193 × $167 = $32,231

Method 2: Comparable Listing Analysis

Manually research active listings:

Process:

1. Find 5-10 comparable listings (same bedrooms, similar location)
2. Note their rates across seasons
3. Estimate their occupancy from calendar
4. Calculate their implied revenue

Example:

Average: $45,683 | Conservative (80%): $36,546

Method 3: Actual Performance Data

If buying an operating property:

Required Documentation:

• Booking platform statements (12+ months)
• Revenue by month
• Occupancy by month
• Cleaning logs/receipts
• Utility bills
• Maintenance records

Verification:

• Cross-reference platform data with bank deposits
• Check for unusual spikes (one-time events)
• Understand seasonality patterns
• Identify personal use days (blocked, not booked)

Seasonality Considerations

STR revenue varies by season:

Monthly projection is more accurate than annual average.

Operating Expense Analysis

Variable Expenses (Revenue-Dependent)

Typical Variable Total: 25-35% of revenue

Fixed Expenses (Revenue-Independent)

Reserve Expenses

CapEx Reserve: 5-10% of revenue

• Furniture replacement
• Appliance replacement
• Major repairs
• HVAC, roof, etc.

Vacancy Reserve: Already in occupancy projection

• Don't double-count

Total Expense Calculation

EXPENSE CALCULATION EXAMPLE

Projected Revenue: $60,000

Variable Expenses:
- Platform fees (14%): $8,400
- Cleaning (10%): $6,000
- Supplies (3%): $1,800
- Laundry/linens (2%): $1,200
- Subtotal: $17,400 (29%)

Fixed Expenses:
- Property taxes: $4,000
- Insurance: $3,000
- Utilities: $4,200
- HOA: $0
- Lawn care: $1,800
- Pest control: $400
- WiFi/streaming: $1,800
- Software: $500
- Subtotal: $15,700

Reserves:
- CapEx (7%): $4,200

Total Operating Expenses: $37,300
Operating Expense Ratio: 62%

Key Investment Metrics

Net Operating Income (NOI)

NOI = Gross Revenue - Operating Expenses

Example:
Revenue: $60,000
Expenses: $37,300
NOI: $22,700

Cap Rate

Cap Rate = NOI / Purchase Price

Example:
NOI: $22,700
Purchase Price: $400,000
Cap Rate: 5.68%

STR Cap Rate Benchmarks:

• Below 5%: Likely overpriced
• 5-7%: Market rate in strong markets
• 7-10%: Good investment territory
• Above 10%: Verify assumptions

Cash-on-Cash Return

Cash-on-Cash = Annual Cash Flow / Total Cash Invested

Example:
NOI: $22,700
Debt Service: $18,000 (mortgage P&I)
Cash Flow: $4,700

Cash Invested:
- Down payment: $80,000
- Closing costs: $8,000
- Furnishing: $25,000
- Reserves: $10,000
- Total: $123,000

Cash-on-Cash: $4,700 / $123,000 = 3.8%

Cash-on-Cash Benchmarks:

• Below 4%: Weak, unless appreciation play
• 4-8%: Acceptable for growth markets
• 8-12%: Good cash flow investment
• Above 12%: Verify assumptions

Debt Service Coverage Ratio (DSCR)

DSCR = NOI / Annual Debt Service

Example:
NOI: $22,700
Debt Service: $18,000
DSCR: 1.26x

DSCR Benchmarks:

• Below 1.0: Negative cash flow
• 1.0-1.2: Tight, little margin
• 1.2-1.5: Healthy coverage
• Above 1.5: Strong cushion

Risk Assessment

Regulatory Risk

Assessment Framework:

Due Diligence:

• Review city/county STR ordinances
• Check zoning for property
• Verify permit requirements
• Research recent regulatory changes
• Assess political direction

Market Risk

Factors to Evaluate:

• Tourism trends (growing/stable/declining?)
• New hotel/STR supply
• Economic dependence (single employer, seasonal)
• Natural disaster exposure
• Competition saturation

Operational Risk

Considerations:

• Distance from you (remote management challenges)
• Local contractor availability
• Seasonality severity
• HOA restrictions
• Property condition

How This Affects Investors

When evaluating STR investments:

Critical Due Diligence:

• Verify revenue claims with documentation
• Independently estimate using market data
• Understand local regulations fully
• Factor all expenses, not just what seller claims
• Apply conservative assumptions

Negotiation Leverage:

• Use underwriting to support offer price
• Don't pay for seller's best-case scenario
• Factor in transition period revenue dip

A marketplace connecting sellers with investors provides access to properties with documented performance.

How This Affects Operators and Sellers

For Sellers:

• Accurate financials help buyers underwrite fairly
• Documentation speeds due diligence
• Realistic expectations lead to smoother transactions
• Verified performance justifies asking price

Documentation to Prepare:

• 12+ months of platform statements
• Expense receipts and bills
• Occupancy calendars
• Revenue by source (Airbnb, VRBO, direct)

STR Underwriting Template

Worked Example: Complete Underwrite

Property Details

• 3BR/2BA house in Gatlinburg, TN
• Asking price: $525,000
• Fully furnished, turnkey
• Operating for 2 years
• Seller provides 24 months of data

Revenue Analysis

Seller's Claimed Revenue:

• Year 1: $78,000
• Year 2: $82,000
• Average: $80,000

Independent Verification:

• AirDNA Market Data: $72,000 median for 3BR
• Comparable listings: $68,000-85,000 range
• Seller's data reviewed: Consistent, verified

Conservative Projection:

• ADR: $225 (seller averaged $235)
• Occupancy: 68% (seller averaged 72%)
• Projection: $55,845 (conservative)
• Base case: $65,000 (80% of claimed)

Expense Analysis

Investment Metrics

Revenue (base case): $65,000
Operating Expenses: $40,700
NOI: $24,300

Cap Rate: $24,300 / $525,000 = 4.6%

Financing (20% down, 7% rate, 30 yr):
Loan: $420,000
Annual Debt Service: $33,500

Cash Flow: $24,300 - $33,500 = -$9,200 (negative!)

Total Cash Required:
- Down payment: $105,000
- Closing: $12,000
- Already furnished: $0
- Reserves: $15,000
- Total: $132,000

Cash-on-Cash: -$9,200 / $132,000 = -7.0%

Decision

At asking price ($525,000), this property:

• Has a cap rate below target (4.6% vs. 6%+ goal)
• Is cash flow negative with standard financing
• Requires seller revenue to be fully realized

Offer Strategy: To achieve 6% cap rate: $24,300 / 0.06 = $405,000 To achieve cash flow positive: Reduce by ~$100,000

Recommendation: Offer $425,000 (19% below asking) or pass.

Common Mistakes to Avoid

1. Using seller's best month annualized: Always use trailing 12 months minimum, preferably 24.

2. Ignoring seasonality: Vacation markets can have 3x variance. Monthly projections are more accurate.

3. Underestimating expenses: STR expenses are 35-50% of revenue. Don't use long-term rental assumptions.

4. Ignoring platform fees: 12-15% goes to Airbnb/VRBO. This is real cost.

5. No CapEx reserve: Furnishings wear out. Appliances break. Budget 5-10% for replacement.

6. Assuming current regulations continue: Research regulatory trends. A legal STR can become illegal.

7. Paying for projected revenue, not actual: Buy based on documented historical performance or conservative projections.

FAQ

What cap rate should I target for STR investments?

Aim for 6-8%+ in most markets, understanding that hot markets may see lower caps. Below 5% is typically overpriced unless you have strong appreciation thesis.

How do I project revenue for a property that hasn't operated as STR?

Use AirDNA data plus comparable listing analysis. Apply conservative assumptions (75-80% of market median). Assume 6-12 month ramp-up period for new listings.

Should I trust seller-provided financials?

Verify everything. Request platform statements, bank records, and expense documentation. Cross-reference claimed revenue with deposits. Healthy skepticism protects you.

How do I account for personal use in projections?

If current owner blocks dates for personal use, that's lost revenue opportunity. Add those nights back at projected ADR for true revenue potential—but confirm regulations allow those nights.

What's a reasonable expense ratio for STR?

35-50% of gross revenue for self-managed properties. Add 15-25% more for professional property management. Below 35% likely underestimates true costs.

How do I value furnishings in a turnkey purchase?

Request inventory with purchase prices. Depreciate based on age. Quality furnishings might be worth $20,000-40,000 for a typical home. Deduct from property price or treat as separate asset.

Should I use IRR or cash-on-cash for STR analysis?

Use both. Cash-on-cash tells you annual return on invested capital. IRR factors in time value and exit value. For short hold periods, cash-on-cash may matter more. For long-term holds, IRR is comprehensive.

How do I factor regulatory risk into my underwriting?

Research thoroughly and price it in. If there's meaningful regulatory risk, apply a discount to your offer or require contingencies. Some markets aren't worth the risk at any price.

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Looking for investment-ready short-term rentals with documented performance? Browse listings on a marketplace connecting sellers with serious investors.

Internal Links:

• Investor Checklist: Analyze Any Rental Deal
• Pricing Furnished Rentals for Maximum Profit
• Insurance Essentials for Furnished Rentals
• Short-Term Rental Regulations: What Investors Watch

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Consult a professional for your specific situation.