Underwriting Made Easy for Short Term Rental Investors

I’m a banker turned real estate investor. Here is a simple way to calculate if an overnight rental will be profitable or not.

Underwriting is a critical part of investing successfully in real estate. In the beginning of my investing career, I let emotional decisions guide me (even though I was a banker with underwriting experience), but now I fully underwrite every deal to ensure the property will make money. Here’s an easy way to determine if the property you are looking to buy will make money.

Cash

First start with your year one cash in the deal. This is actual out of pocket cash – everything from your down payment and closing costs to rehab and / or furniture purchases. Not your mortgage, just cash out of pocket in year one of buying and then owning the property.

NOI

Next, calculate your net operating income (NOI). NOI is a critical piece of this equation. You’ll figure out what you expect to make in rental income for the year. Next subtract out all operating expenses for the year. This will give you the expected net income that you’ll make if you stay true to those numbers. Conservative underwriting is crucial during this step. Don’t over inflate rent or underestimate expenses. If the property is older, you may want to consider including a replacement reserve line item. This would be an expectation of additional funds that may need to come out of pocket if something becomes broken or in need of repair.

Cash on Cash

Finally, divide the cash out of pocket by the net operating income to come up with your cash on cash number. This is the percentage of income you expect to make on each dollar that comes out of your pocket in year one. 20% is a good benchmark for most investors.

Some calculators allow investors to project this figure out multiple years to see a long term view of the investment properties performance. A free app that I recommend investors utilize is called Deal Check.