Comparing the Top Down and Bottom Up Approaches to Short Term Rental Analysis and Underwriting
As a short term rental investor, you know that finding properties with strong potential for revenue is key to your success. One way to do this is by using either a top down or bottom up approach to analysis and underwriting. Both approaches aim to find properties where the annual gross revenue is greater than the target unlevered yield on cost plus a margin of safety. In this blog post, we’ll delve into the details of each approach and help you determine which one is best for your investment goals.
The top down, market based approach involves using online market data tools like AirDNA to identify markets where the annual revenue per average purchase price is greater than the target unlevered yield on cost. From there, you can focus on neighborhoods, zip codes, and streets with the highest performing properties. To get a better understanding of the potential gross revenue of properties in these areas, you can compile a table of gross revenue by bedroom count and purchase price. By analyzing trends between bedroom count and purchase price, you can determine whether you can potentially buy more revenue by purchasing a studio instead of a 1 bedroom property.
Another important aspect of the top down approach is identifying the features, aesthetics, design, and amenities that are required or are “table stakes” in high performing properties in the market. You can also use this information to identify value-add opportunities and ROI boosters through targeted updates and the addition of high demand features. For example, if you notice that properties with swimming pools or hot tubs tend to perform better in a certain market, you may want to consider adding these amenities to a property you are considering purchasing. Similarly, if you see that properties with mini-golf courses or go-kart tracks are in high demand, you may want to consider adding these features to your property to increase revenue.
One of the benefits of the top down approach is that it allows you to analyze and acquire properties at scale. However, it also has its drawbacks. The process of identifying markets and analyzing data can be time-consuming and may require a significant amount of labor. Additionally, access to data tools like AirDNA can come at a cost.
On the other hand, the bottom up, property based approach involves identifying markets that you believe will drive high yields based on more qualitative factors and easily digestible data, such as market reports or word of mouth. Once you have narrowed down your list of markets, you can set up searches on websites like Zillow or Redfin to find properties that meet your investment criteria.
To analyze a potential deal using the bottom up approach, you can use a free short term rental deal analyzer spreadsheet calculator. This will help you to substantiate the revenue potential of a property by looking at nearby properties and estimating what the revenue would be for the subject property. In addition to evaluating the features and amenities that a property has, you can also consider factors such as the level of finish of the home, whether it has views or is waterfront, and whether it has any value-add opportunities.
Once you have identified a property that meets your investment goals and has a clear path to optimize revenue with a margin of safety, you can create a value-add strategy to increase the projected revenue. For example, you may decide to modernize an older property to increase its average daily rate by 20% or more. Alternatively, you may decide to add high demand features to the property to increase its appeal to renters.
One of the benefits of the bottom up approach is that it is easy to get started and can typically be done in 90 minutes or less. It is also a free method of analyzing potential deals. However, it can be difficult to scale this approach by analyzing every deal individually, and the process of identifying target markets can be haphardous without a clear, data-driven method. Additionally, while the bottom up approach is a good option for investors who are just starting out and want to get a feel for the market, it may not be as efficient in the long term as the top down approach, which allows for more comprehensive analysis and acquisition at scale.
Ultimately, the best approach for you will depend on your investment goals, budget, and time constraints. If you have the resources and are looking to acquire properties at scale, the top down, market based approach may be the way to go. However, if you are just starting out and want to get a feel for the market, the bottom up, property based approach can be a good option. No matter which approach you choose, it is important to keep in mind that both require a thorough analysis of the property’s potential revenue, as well as a clear path to optimizing that revenue with a margin of safety. By carefully considering these factors, you can make informed decisions that will help you achieve success as a short term rental investor.
