Do you understand your business model? A VRBO example.

In every business in every industry, there are a variety of actors and participants. A business model is simply an outline and clarification of how you make money offering the product that you offer. When diving into any business, though, it is important to understand where the money is flowing and who the elephants in the industry and supply chain are. Often times, where you think the money is is not actually where it is.

Let’s look at VRBO activity today as an example. These take many forms but the two basic models are I have an extra house I don’t use all the time and I want to rent it out and make a little money. I don't really care about the profit and the returns because I don’t have to worry about the cash flow and my main goal is to use it. The other form is I am going to buy this house and rent it out ad hoc, make a profit and maybe even get to use it for free too. The latter is a business intent. Before you get into it, understand who is making the money where you are.

Central to any real estate purchase, from a financial view, is cap rate. I’ve written a previous brief on cap rate. Be sure to read that. With a VRBO, you have new tenants every few days. The risk level is higher than with a straight long term rental. As such, your returns should be higher for accommodating that risk. So, the first question is can it generate enough revenue to generate enough net income to hit the cap rate required?

Many people purchase a property without actually calculating likely, max and min potential revenue based on logical occupancy rates for the area. $200 a night sounds good but if reasonable occupancy is 20% of available room nights, it might not be that good. So, understand your revenue potential and likely numbers. Understand what it will take to get that revenue and who the intermediaries are that you may have to go through. Stress test your model at varying occupancy rates. If you are being told the occupancy rates are high (75% for example), test out why that is. Don’t take it as fact. Are there any demand drivers in your area during the week? Consistently during the week. Two festivals a year does not a profitable rental make.

Next, what are your costs. This gets into understanding who makes money. To generate your revenue, you are going to almost certainly have to use a booking site like vrbo.com or airbnb.com. They take their cut. It’s large. Yes, you can put that on to the customer but it does add heft to your bill. It’s not an invisible cost any more than real estate broker fees are invisible.

After that, what do you have? Electricity, gas, water, cable, internet, maintenance on the hot tub, supplies. But, what supplies? Towels, pillows, toiletries, etc. These wear out much faster than the ones at home do, particularly if you want to maintain a good guest experience.

What else? CLEANING. You have to clean the property. You can hire people or a service or you can be the maid yourself. But, did you buy a VRBO property so you could be a maid? You can get that job for free and people will pay YOU to do it. That’s a hard job. But, be careful. Here is where the business model gets fun. This can get very expensive. Particularly if the service is charging a percent of the revenue. Particularly if you are in an area that sells this dream to people who don’t live in that town. The locals will fleece you so, you have to understand this component well.

In my experience, the biggest determinants to your profit outside of Revenue are as follows

Booking costs

Cleaning costs

Property tax

Maintenance

To generate max returns, you have to bring as much of this internal as you can. For example, in the cleaning service fee, why would you pay a percent of revenue? A three night stay becomes 3x as expensive as a 1 night stay but with the same work for the cleaning team. Break their costs down to the hour and make it a checklist. Make sure they earn enough to justify their travel time to your place. Make sure they earn enough from you each month to make it interesting. Hire individuals and not a service. Regardless, break down their costs and control them or it will eat you. If too many people are taking their cut, there won’t be anything left for you to eat.

The same is true for maintenance and booking, to an extent.

You may not be able to control all but if you don’t control a majority, you’ll be in sad shape with your financials and there will be no profit left. And, that’s sad. It makes me sad when there is no profit.