The Importance of Unlevered Yield in Short-Term Rental Investing

When it comes to evaluating short term rental investments, it’s essential to consider the unlevered yield or unlevered yield on cost (UYOC). This financial metric measures the potential return on investment of a property without taking into account any debt or leverage. In other words, it treats the project as if it will be done all-cash, with no debt. It’s important to note that if there is no debt or leverage, UYOC will be equal to the return on investment (ROI).

There are several reasons why UYOC is so crucial in short term rental investing. First, using leverage can make a mediocre investment appear good or even great, especially if you forecast high gross annual revenues for the property. However, forecasting rent growth involves making assumptions about the future that may not come to fruition. By focusing on UYOC, investors can avoid basing their investment decisions on these assumptions and instead focus on the property’s current profitability. This reduces the risk of unpredictable factors on an investment property.

Second, using leverage puts investors at the mercy of the debt markets. If the banks decide to change the terms of their loans or refuse to lend at all, it can have a significant impact on an investor’s profitability. By focusing on UYOC, investors can ensure that their investments are financially viable even if the banks are unwilling to lend. Loan terms can change quickly, often in weeks or months during periods of macroeconomic stress, even if they are unrelated to the investment property.

Finally, UYOC helps investors understand the potential returns of an investment without the added risk of leverage. While leverage can increase returns in the short term, it also increases risk. By considering UYOC, investors can understand the potential returns of a property without the added risk of leverage.

Overall, UYOC is a crucial metric to consider in short term rental investing. It helps investors understand the potential profitability of a property without taking into account any debt or leverage, and ensures that their investments are financially viable even if the banks are unwilling to lend. By considering UYOC, investors can make informed decisions about their short term rental investments and increase their chances of success by better predicting outcomes through the reduction of unpredictable risk factors.

Shout out to Moses Kagan for hammering this point home to me and so many others.