One of the best ways to explain how a Serviced Accommodation (SA) unit can offer great Returns on Investment (ROI) is by comparing it to something of equal expense. Let’s say a Buy-to-Let (BTL).

So that’s what we will do. We’ll take a look at a specific property and consider it being operated as a short-term let. We will do a cash-flow analysis over the course of a year, taking into account all revenue and major expenses, and compare this to an equivalent buy-to-let model.

At the end we can compare the profit of each and determine which of the two models offer a greater ROI. Let’s begin.

Take a look at the property below, 48 Willowbrae Road, Edinburgh. It’s a two bed bedroom flat with a kitchen, living room, box room and bathroom. The flat is situated 20 minutes from the city centre by bus, is in close proximity to Arthur’s Seat, a supermarket and is in a desirable location for both tenants and guests.

The value of this flat would be approximately £240k. A 25% deposit for this flat would be £60k, leaving a £180k mortgage. Let’s now compare the two models. First…

**BTL**

**Income**

I know from personal experience that this property has recently rented for £800pcm. That’s a 4% yield. Let’s be generous and assume that it actually rents for 5%, which is the equivalent of £900pcm.

Therefore:

- Income = 5% of £240k = £12,000/year

**Expenditure**

The main operating costs associated with a BTL are the maintenance and mortgage interest payments. Maintenance costs are typically 20% to 30% of Rent. Let’s again be generous and say that it’s the lower mark, 20%. With regards to the interest on a mortgage, 3% would also be a very appealing, but reasonable rate. For the time being we will assume that there is no letting agent fee.

Therefore:

- Maintenance Costs = 20% of £12,000 = £2,400/year
- Interest Payments = 3% of £180k = £5,400/year
- Letting Agent Fee = £0
- Total Expenditure = £7,800/year

**Profit**

- Profit = £12,000 – £7,800 = £4,200/year
- ROI = 100 x £4,200 / £60K = 7%

**Note**

If we were to consider tax, then the profit from a BTL would certainly be smaller than the figure suggested above. This is owing to the fact that mortgage interest payments are a post-tax deductible expense for BTLs, as well as a number of maintenance costs.

**SA**

**Income**

The average nightly rate for a short-term let is £100/night and occupancy rates are 83% according to our Short-term let prospectus for Edinburgh. After checking similar listings in the local area, these assumptions would also appear to hold true for this property as well. Let’s be conservative and assume that the actual occupancy rate for this example will be 75%.

Therefore:

- Income = 75% of £100 x 365 = £27,375/year

**Expenditure**

There are a number of costs associated with a SA unit. There are certainly many more than a BTL, but bear with me. Some expenses are related to how regularly the property is booked and some are fixed throughout the year.

Let’s start with the fixed expenses as they should be fairly straight forward. We will assume that the mortgage interest rate is identical to that of a BTL (3%), however the maintenance costs are 30% of a BTL’s annual rental income rather than 20%. This is likely as the standard and condition of furniture and fixtures in a SA unit are expected to be higher. We will also make a fairly accurate assumption towards other monthly fixed costs.

Therefore:

- Maintenance Costs = 30% of £12,000 = £3,600/year
- Interest Payments = 3% of £180k = £5,400/year
- Gas and Electricity = £75/month
- Deep Clean = £50/month
- Broadband = £20/month
- TV License = £13/month
- Contents Insurance = £24/month
- Public Liability (£1m) and Professional Indemnity (£0.25m) = £18/month
- Replenishable Stock = £40/month
- Total = £11,880/year

Now we will consider the variable expenses, such as commission from booking platforms which fluctuate depending on the number of nights booked. It would be reasonable to assume that commission is 10% of revenue. With regard to the other variable expenses, to make these assumptions, we must first understand how long the average guest plans to stay for. According to a recent hotel prospectus, this stood at 3.6 nights per guest; however, we will assume a worst case scenario of 2.5 nights per guest. This means more changeovers and therefore greater expenses. We shall also assume that there is no management fee.

Therefore:

- Commission = 10% x 27,375 = £2,738
- Number of bookings per month = 75% of 30 / 2.5 = 9
- Welcome Pack = £5 x 9 = £45/month
- Cleaning = £25 x 9 = £225/month
- Linen & Towel Rental = £20 x 9 = £180/month
- Management Fee = £0/month
- Total = £8,138/year

Therefore the total for variable and fixed costs is:

- Combined Expense = £11,880 + £8,138 = £20,018

**Profit**

- £27,375 – £20,018 = £7,357/year
- ROI = 100 X £7,717 / £60K = 12.3%

**Note**

The majority of expenses if not all can be claimed as a tax deductible which is very good news as this lowers our tax bill significantly.

**Comparison**

Now that we have cash-flow results for the two different models, we can now compare their ROI. The most important part of the analysis is the profit. As we can see, the profit from the SA unit is significantly greater than that of the BTL with a respective 12.3% and 7% ROI in the first year. This is despite the fact that I have been overly optimistic with respect to the BTL’s revenue and expenditure. Meanwhile, I have been pessimistic with the performance of the SA unit. The reality is that the SA unit would likely surpass its current profit margin if the true data had been used.

If I was to take the true number of the nights that the average guest stayed (3.6) then the ROI would then rise to 15%. If the occupancy was also to remain at 83% like originally stated, the ROI would be 18.7% (£11,200).

The difference is even more significant when tax is taken into account. There are many more tax advantages for operating a SA unit than a BTL, which means more revenue can be retained.

We will also perform a stress test against both models in the form of a rapid increase in mortgage interest rates. What would happen if the interest rates went from 3% to say 6%, which is similar to those rates before the financial crash in 2008. Well immediately we notice that the ROI for the BTL model falls to -2%. In simple terms that’s a £1,200 loss. Whereas our SA model falls to 3.3%, which is just under a £2,000 profit. So we can see that the SA model is much more resilient to interest rate changes than a BTL.

The proof is in the maths. In many cases, SA is a vastly superior investment strategy compared to BTL. However, this does not always hold true for certain locations. Even within Edinburgh, where the consensus seems to be that everywhere is a goldmine for SA, there are neighbourhoods which might lend itself more towards to a BTL model.

The real question is, are you sitting on a BTL, which if reconfigured to a SA unit, could increase your pre-tax profit by 200% or 300%? Would that make a significant difference to your life? Maybe not, but it could pay for that extra holiday you’ve always wanted, or for you to potentially consider taking a slightly earlier retirement.