How do you evaluate STR arbitrage investment?
Member since 2021 · 42 posts · 19 votes
I was wondering how you evaluate investment with limited or no equities such as STR arbitrage. Since when the lease is up, you have nothing in the deal other than a few years old furniture, whose value would be limited if anything.
My initial thought would be to evaluate it like a hotel, which is usually evaluated with a payback period, but in a hotel deal the investment usually includes the land and buildings, which have significant value on exiting.
Any pointer would be appreciated.
@Patrick K. I'm not a big fan of the model, however, I love numbers. :)
Here's how I would evaluate: (all numbers are random, just for example)
Setup cost divided by the lease term. $36,000 setup, 36 month lease term = $1,000/month
Add all monthly expenses so you know what is expected outflow.
Setup cost $1k/month, + lease $3k/month, plus insurance $1,250/month, plus utilities $350/month, plus maintenance $150/month, etc, = $5,750 expected outflow/month
Then take expected income $7,500, subtract expected outflow of $5,750 = $1,750/month expected incom
Multiply $1,750 times lease months (36) to get gross expected profit ($63,000) and subtract setup cost to get net expected profit ($63k-$36k) = $27k
To get total ROI multiply monthly expected expenses by lease term, add setup cost, then divide gross expected profit by the result (($5,750*36)+$36k) = $243,000
ROI $63000/$243,000 = ~26% or ~9%/year.
All numbers made up on the spot for visual display of calculations. Again, this is not something I have any interest in, so I would definitely want to fine tune my equations before building a spreadsheet to calculate.
Off the top of my head, this is how I would evaluate arbitrage. I hope it's helpful as a thought exercise at least.
I'd just keep it simple. Cash in/ cash out.
How much will this rent for each night? What is a reasonable occupancy rate? That is your estimated income.
Minus the costs to run it: rent, insurance, automated online services, cleaning (although guests usually pay for this) utilities, internet, disposables.
Once you have that number? How much is the spread? Is it worth it? How many months will that spread take to pay back for your initial deposit and furniture?
If you are comfortable with the returns, go for it. If not, don't.
There is no set return that is "good" or "bad." It's what you think is worth your time managing it.
Hope this helps. Don't overthink it and fall into analysis paralysis. You got this! :) Good luck! I'm rooting for you!
Hey @Patrick K., I am not the biggest fan of arbitrage but I can see where you would want to make sure you aren't going to get killed on the deal.
Make sure you include the payback for the setup outlay. Cleaning costs are a passthrough to guests.
Remember you need to provide STR insurance as well.
Look at all the comps on AirBNB and VRBO to see what others are charging for similar properties.
In order to account for the cost/risk of your rental payment, I would measure it based on ($ cash flow)/($ rent). Meaning you mathematically adjust for the higher overhead costs; if you have a bigger rent payment due at the beginning of the month, then you need to be making more cash flow to accommodate the additional risk.
@Patrick K. I'm not a big fan of the model, however, I love numbers. :)
Here's how I would evaluate: (all numbers are random, just for example)
Setup cost divided by the lease term. $36,000 setup, 36 month lease term = $1,000/month
Add all monthly expenses so you know what is expected outflow.
Setup cost $1k/month, + lease $3k/month, plus insurance $1,250/month, plus utilities $350/month, plus maintenance $150/month, etc, = $5,750 expected outflow/month
Then take expected income $7,500, subtract expected outflow of $5,750 = $1,750/month expected incom
Multiply $1,750 times lease months (36) to get gross expected profit ($63,000) and subtract setup cost to get net expected profit ($63k-$36k) = $27k
To get total ROI multiply monthly expected expenses by lease term, add setup cost, then divide gross expected profit by the result (($5,750*36)+$36k) = $243,000
ROI $63000/$243,000 = ~26% or ~9%/year.
All numbers made up on the spot for visual display of calculations. Again, this is not something I have any interest in, so I would definitely want to fine tune my equations before building a spreadsheet to calculate.
Off the top of my head, this is how I would evaluate arbitrage. I hope it's helpful as a thought exercise at least.
@Patrick K. I'm not a big fan of the model, however, I love numbers. :)
Here's how I would evaluate: (all numbers are random, just for example)
Setup cost divided by the lease term. $36,000 setup, 36 month lease term = $1,000/month
Add all monthly expenses so you know what is expected outflow.
Setup cost $1k/month, + lease $3k/month, plus insurance $1,250/month, plus utilities $350/month, plus maintenance $150/month, etc, = $5,750 expected outflow/month
Then take expected income $7,500, subtract expected outflow of $5,750 = $1,750/month expected incom
Multiply $1,750 times lease months (36) to get gross expected profit ($63,000) and subtract setup cost to get net expected profit ($63k-$36k) = $27k
To get total ROI multiply monthly expected expenses by lease term, add setup cost, then divide gross expected profit by the result (($5,750*36)+$36k) = $243,000
ROI $63000/$243,000 = ~26% or ~9%/year.
All numbers made up on the spot for visual display of calculations. Again, this is not something I have any interest in, so I would definitely want to fine tune my equations before building a spreadsheet to calculate.
Off the top of my head, this is how I would evaluate arbitrage. I hope it's helpful as a thought exercise at least.
@Richard Elvin Thanks for this Richard, I think you counted set up cost twice in your formula. But my problem with a ROI model is this, for a regular real estate deal, the I (investement) is usually paid back on exit, i.e. you have sold your house. But in arbitrary senario. your investment is furniture, which has no exit values. There should be an analysis that is universal to both senarios.
I heard a detailed podcast with Michael and Elizabeth Chang (well-known arbitrage operators and mentors) and they explained how to analyze an arbitrage deal very well. I made note of it in case it ever came in handy but have never personally done an arbitrage unit.
So, when it comes to expenses and profit you would run numbers the same as any other STR property that would have a mortgage on. But when it comes to investment you would need to be sure to get everything back within 6 months. For example, add up furnishing and deposit, all other expenses would be the same as a home you own. Then find out what the projected revenue would be for 6 months. If the total amount for furnishing/deposit is not completely returned within those 6 months, it would not be an ideal property to use for STR Arbitrage.
First 6 months=repay for furnishings/deposit.
Last 6 months and beyond=full on profit after expenses.
Your "equity" is taking that profit to go buy an investment property. And if you can take the first 6 months reimbursement to go set up another property and run through the scenario again, you can purchase an investment property faster.
And this is how anyone can change their family's generational wealth!
@Patrick K. You are correct, I added the setup costs spread across the 36 month term, then again as a one time cost. Good catch! This is why I go through formulas, and have others double check them, before creating spreadsheets. Lol
For rental arbitrage, I only take/took deals that were profitable year 1. Unless signing a multi-year lease, there's no guarantee you'll be renewed a second year.
Don't really look for these anymore and ones I've done lately were brought to me from landlords I worked with previously. In those situations I'm in a position to get better terms.
#'s wise it's your up front expenses: rent, furniture, decor, etc plus your ongoing maintenance and cleaning expenses. Then, whatever you estimate your revenue to be over the coming months/year. Account for seasonality in your numbers to come to a final anticipated profit figure.
Make sure it's a healthy profit as a margin of safety in case things go sideways. If possible, have some out clause in your lease that allows you to bail before it really goes south. This isn't always possible.
I know rental arbitrage is an attractive thing from those on the outside, but the real $ in this was made before everyone was talking about rental arbitrage. It's much much tougher now to find a deal that'll actually compensate you for the work. Remember, you're not building any equity, you're not getting any big tax advantages, you're simply renting and operating for X price, and banking that Y revenue is going to be significantly more. It's a strictly cashflow play, and the margins are much slimmer than they were years ago.
I would analyze an arbitrage the same as an owned investment. Replace the mortgage payment instead with a monthly rent payment, add up all other expenses, then subtract from your reasonably numbered monthly gross income based on market trends for nightly rates for your size property with similar design and occupancy rates of the area.
Once you get this number add up the yearly net income and divide it by total cash invested and you will get your ROI number to tell you if you think it will be a good investment or not.
Usually rental arbitrage units you want your ROI to be several notches higher than if you owned. For STR think 15% minimum and up on ROI for owned investments. Think 30% and way up for arbitrage investments.
I would analyze an arbitrage the same as an owned investment. Replace the mortgage payment instead with a monthly rent payment, add up all other expenses, then subtract from your reasonably numbered monthly gross income based on market trends for nightly rates for your size property with similar design and occupancy rates of the area.
Once you get this number add up the yearly net income and divide it by total cash invested and you will get your ROI number to tell you if you think it will be a good investment or not.
Usually rental arbitrage units you want your ROI to be several notches higher than if you owned. For STR think 15% minimum and up on ROI for owned investments. Think 30% and way up for arbitrage investments.
imo Arbitrage gotta be over 100% ROI year one. Otherwise, not worth doing since you can't control a renewal for second year. Meaning, you have to recoup all your furniture and decor and set up expenses (invested capital) 100% before you make any money. Guess some could argue there's liquidation value in the furniture or use in other units, but I've found that to be negligible and not worth factoring into the deal.
I would analyze an arbitrage the same as an owned investment. Replace the mortgage payment instead with a monthly rent payment, add up all other expenses, then subtract from your reasonably numbered monthly gross income based on market trends for nightly rates for your size property with similar design and occupancy rates of the area.
Once you get this number add up the yearly net income and divide it by total cash invested and you will get your ROI number to tell you if you think it will be a good investment or not.
Usually rental arbitrage units you want your ROI to be several notches higher than if you owned. For STR think 15% minimum and up on ROI for owned investments. Think 30% and way up for arbitrage investments.
imo Arbitrage gotta be over 100% ROI year one. Otherwise, not worth doing since you can't control a renewal for second year. Meaning, you have to recoup all your furniture and decor and set up expenses (invested capital) 100% before you make any money. Guess some could argue there's liquidation value in the furniture or use in other units, but I've found that to be negligible and not worth factoring into the deal.
I would agree on a personal note I think a good arbitrage unit should be 100% return first year. I wouldnt settle for the risk of not recouping furniture first year unless the lease is multiple years. Overall I just dont like arbitrage. I had 3 units and sold them all . they were okay but a waste as I should have used all that money to do a down payment on a property instead.
I would analyze an arbitrage the same as an owned investment. Replace the mortgage payment instead with a monthly rent payment, add up all other expenses, then subtract from your reasonably numbered monthly gross income based on market trends for nightly rates for your size property with similar design and occupancy rates of the area.
Once you get this number add up the yearly net income and divide it by total cash invested and you will get your ROI number to tell you if you think it will be a good investment or not.
Usually rental arbitrage units you want your ROI to be several notches higher than if you owned. For STR think 15% minimum and up on ROI for owned investments. Think 30% and way up for arbitrage investments.
imo Arbitrage gotta be over 100% ROI year one. Otherwise, not worth doing since you can't control a renewal for second year. Meaning, you have to recoup all your furniture and decor and set up expenses (invested capital) 100% before you make any money. Guess some could argue there's liquidation value in the furniture or use in other units, but I've found that to be negligible and not worth factoring into the deal.
I would agree on a personal note I think a good arbitrage unit should be 100% return first year. I wouldnt settle for the risk of not recouping furniture first year unless the lease is multiple years. Overall I just dont like arbitrage. I had 3 units and sold them all . they were okay but a waste as I should have used all that money to do a down payment on a property instead.
You get in where you fit in. Arbitrage got my foot in the door. Learned the ropes, introduced me to others in the game. That led to management deals and additional arbitrage opportunities that made sense at the time. One of those arbitrage deals I had 6 units with same owner when COVID hit, I got out, found long term tenants to replace me and that owner funded stuff for us to buy together. Why? Cuz I knew how to operate a STR, he didn't. His market was shut down, I moved to one that was open. I became the only guy who he could still do deals with when everyone he knew locally was stuck waiting for things to open up.
I guess my point is, deal has to make sense from pure analysis point, but I don't hate on guys just trying to hustle and make a buck doing whatever they can. Never know where it leads.
Also, arbitrage is way less risk than buying. Significantly less capital and you get to run your test on a property or new market/neighborhood for a year and see with real numbers whether it's worth doing again. Sure, your upside is capped, there's no equity gained, it's purely cashflow, but 5-6 great arbitrage units can replace a full time income. You just have to be very disciplined in what leaseholds you take on. Need to know you have a healthy margin between your base rent and what you can generate monthly.
Years ago, I managed an account for a friend who leased a 4 unit building. Just 1 of those units did 20k monthly in gross revenue. His rent on that unit? 4500. Those types of deals are few and far between, maybe impossible now, but seeing that was eye opening for me.