Buying a Vacation Rental (Guide to Investing in Short Term Rentals)
Short-term vacation rentals can be a very profitable real estate venture. Similar to a hospitality service in some aspects, a vacation rental property offers luxury and comfort to its guests, in exchange for a greater nightly rate and the flexibility of short-term renting.
If approached the right way, buying a vacation rental can be a valuable addition to your real estate portfolio. But potential owners must be very careful in their selection of vacation homes, the ins and outs of the expenses and income, as well as the type of financing they choose for their investment property. There are many things to consider when buying a vacation rental.
Thus, in this guide, we will go over the most important aspects to keep in mind when buying a vacation home. We will look at the benefits and risks, and offer crucial advice to make your real estate investment a worthwhile one.
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Why Vacation Rental Properties Are a Smart Investment
Before getting into the technicalities of buying a vacation rental property, we will look at what motivates real estate investors to consider this as a good option. There are several unique benefits of investing in short-term vacation rentals, and we will tackle each individually.
It Creates an Additional Income Stream
While all investment properties eventually create an additional income stream, generally after the mortgage is paid off, short-term rentals offer the possibility to create it right now. Although there are more factors to be taken into consideration, such as cleaning fees or utility bills, the higher nightly rates often generate profit on a year-by-year average.
More stable real estate ventures, such as long-term rentals, only allow the owner to match the property expenses through rent most of the time. But vacation rentals cover the expenses just as well, while also generating profit on the side.
You Are Able to Use It
Long-term renting allows tenants to have a stable place to live in undisturbed for a longer timespan. In that sense, the owner cannot exactly access the vacation home at will, live in it, or use it as a weekend getaway.
However, these aspects change when it comes to owning a vacation rental property. It would only be occupied in accordance with the booking schedule, leaving the owner plenty of days to block out for personal use. Of course, the frequency of doing this can be bad for business, but the possibility to take a vacation anytime with limited housing expenses surely counts as a benefit.
You Can Take Advantage of Tax Deductions
Tax deductions are a very strong benefit to owning a vacation rental. Because business operations are more complex, there are more aspects that can fall under deductibility than with a long-term rental.
Among the most common, we can mention maintenance, cleaning, transportation expenses, supplies, accounting and marketing fees, and insurance. But other, less obvious aspects, such as service fees, workations (a combination of work and vacation time), and software such as photo editors or chatbots. Under the right conditions, you could also qualify for QBI deduction, allowing you to get 20% of your rental income back.
You Have Built-in Advertising
In most business ventures, marketing is an expense that comes with the territory. However, vacation rentals offer a little bit of a loophole here. Owners generally engage in short-term renting via vacation rental platforms, such as Airbnb or Vrbo, which are already popular in the vacation and tourism markets.
While you still need to take care of photo quality, respond to messages, and arrange stays, the visibility offered by these platforms makes everything easier. You don’t need to invest in expensive ad campaigns or have a detailed social media marketing plan. Everything is already on the table.
Vacation Rentals Will Appreciate in Value
This advantage can also be attributed to long-term, classic rentals, but is even stronger with vacation properties. Except for the Covid-19 hiccup, the tourism industry is constantly growing and expanding, and so are the costs of vacation rental properties.
As the world becomes more interconnected and tourism grows insignificance, you can expect large returns on the overall value of the property. This can also translate into higher nightly rates and a constant rental income.
You Can Use It as a Retirement Property
Everyone dreams about living out their golden years in an exotic place that is full of life. A vacation rental property can be exactly that if you play your cards right. Not only will the business model allow you to reap additional rental income during your loan, but it will also ensure that everything can be paid off once you decide to retire.
Instead of saving up for a dream property to buy and use during retirement, you can own one right now, take advantage of all the benefits that come with it, and be able to retire in it when the time comes.
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The Cons You Need to Be Aware Of
Like with any other type of investment, vacation rentals are not a financial miracle. There are some downsides to owning a vacation rental property that any prospective buyer would need to be aware of. We will go through the most important ones in this section, as well as some solutions that you can use to overcome them.
Irregular Income
Short-term vacation rentals are part of the tourism industry. Like everything else in tourism, earnings may go down drastically during the off-season. Although in most cases, the tourism season will cover the expenses of the other months, the owner needs to cover the property’s expenses with this irregular rental income.
In other words, while some months may be abundant in terms of cashflow, others may take a toll on your financial health through the urgency of paying property expenses. In this sense, vacation rentals are riskier than their long-term counterparts.
Solution: Smart Budgeting
Budgeting is key to properly managing irregular income. For vacation rental owners, this is paramount to ensure that the property does not end up causing trouble down the road. As an owner of a vacation rental property, you should have enough in your account to cover at least 3 months of expenses.
Such a budget would give you enough time to re-assess your strategy, reach the peak of the tourism cycle, or consider other financing routes. Ideally, the budget would hold until the next cycle of considerable earnings, allowing you to replenish it and take in profits comfortably.
Property Management Company
If you are not living close to your vacation rental property, chances are that you will have to start working with a property management company. While this may remove the need for you to regularly visit the vacation rental and take care of on-site guest logistics, it may increase the cost of running a short-term rental.
Solution: Fee Calculation
When calculating your vacation rental property’s nightly rate, you can add a fee specifically aimed to cover the costs of a property management company. In fact, we advise you to do this for all expected expenses, including cleaning and utilities. We will come back to the topic of calculating expenses and fees later in the guide.
Economic Downturns
Shelter is a basic human need, meaning long-term rental assets have constant, reliable demand. However, vacation rentals are more of a luxury service, one that goes hand in hand with tourism.
As such, owners of vacation rental properties are more vulnerable to economic downturns, which often erase large chunks of the tourism market. The Covid-19 pandemic alone forced vacation rental owners to incur large losses. Thus, the risk of a severe reduction in rental income in case of an economic crisis must be taken into account when dealing with vacation rentals.
Solution: Switch to Long-Term Renting
There is no rule stating that vacation homes bought for short-term renting cannot be switched to long-term arrangements. In fact, in case of an economic downturn, making this move may help you cover your mortgage expenses without compromising any savings.
The main issue with this approach is that people searching for long-term rent in touristic areas are rather scarce, hence why it may take some time for you to find tenants. But with the right conditions, it can certainly be done.
We have another article on How To Increase Your Vacation Rental Income that you should read to get you started off on the right foot of maximizing your short-term rental revenue.
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Now that we have compiled a list of the pros and cons of owning a vacation rental property, we will move on to the pragmatics of making such an investment. We will consider 3 crucial steps for purchasing a vacation rental:
Step 1: Choose a Great Vacation Rental Property;
Step 2: Calculate Your Income and Expenses;
Step 3: Consider Your Financing Options.
If you don’t want to rack in hours and hours of real estate investment strategies and terminology, we can do it all for you. Book a call with a Persinger Group representative to get started today!
Step 1: Choose a Great Vacation Rental Property
Investing in vacation rentals starts with making the right choice. To ensure that your property successfully manages to attract guests, you will have to consider a handful of factors, such as location, proximity to tourist attractions, as well as how the vacation rental fits into your budget.
Location
Location is a crucial aspect to consider for any property investment. You can either choose a vacation rental that provides a luxurious stay for the guests, or one that offers nightly stays for cities with a high transit volume. While the latter is certainly a sound real estate investment strategy, we will focus more on the former.
What must be taken into account, in terms of vacation rental location, are nearby restaurants, bars, clubs, and means of transportation. This checklist is quite important because it ensures that guests will have everything they need nearby, thus increasing the chances of renting the vacation property regularly.
Proximity to Tourist Attractions
For most vacation rental guests, visiting the local area and its landmarks is the most important part of their stay. Making sure that the vacation property is near important tourist hotspots improves your chances of having more bookings throughout the year.
Luckily, areas close to must-see landmarks generally have restaurants, bars, transport, and entertainment zones nearby. However, this may also be a double-edged sword, seeing as nobody wants to spend their nights next to loud music, noise, or general disturbance. You must find the right blend among these elements to find the vacation rental that is right for you.
Budget Compatibility
Lastly, even if the vacation property scores well on all the aforementioned points, the most crucial aspect is for it to properly fit your budget. A vacation rental property should not become a financial burden and real estate investors should never bite off more than they can chew.
Mainly because an ultra-central vacation property generally comes with a hefty price tag, prospective property owners should look for bargains more than going for the most expensive properties on the market.
Using Vrbo and Airbnb for Market Research
One lesser-known tip about investing in vacation rentals is to use the local Airbnb and Vrbo markets for research. You can see exactly what kind of properties perform best, what their nightly rates are, as well as what kind of amenities and aesthetics they have.
Researching the vacation rental platforms will help you manage future income expectations, give you the rate parameters you can use, as well as help you compare the vacation properties you are interested in with those already on the market.
This tip will also help you understand what kind of renovation requirements you will have to fulfill. Chances are that your vacation rental investment will not come fully renovated and equipped, and seeing what the best-performing properties have will help you see what you need to provide to have a successful short-term rental business.
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If you don’t want to rack in hours and hours of real estate investment strategies and terminology, we can do it all for you. Book a call with a Persinger Group representative to get started today!
Step 2: Calculate Your Income and Expenses
After finding a couple of options for your vacation rental property, your main concern should be whether the financial side checks out. In other words, you must calculate your income and expenses to see if the rental investment will be profitable, at a break-even point, or at a loss.
Total Property Costs
Your expenses for buying a vacation rental may vary according to your financing scheme. However, a mortgage may be the only realistic option for most real estate investors. Therefore, the mortgage payment must be factored in the expenses, as well as the need to pay it monthly, regardless of tourism cycles.
The other expenses that must be taken into account are the utilities, cleaning fees, property management company fees, and reparations. Unlike long-term rentals, vacation property owners will need to cover utility bills from the monthly earnings. This should not be a major problem, seeing as the use of utilities is only high when the occupancy rate is also high.
Cleaning fees are a foreseeable expense only when you expect to hire cleaning professionals for the job. If you plan to do it yourself, the cost will be one of time, not a financial one. But you must consider whether your schedule and location allow you to take care of this aspect properly, as it is quite a make-or-break condition for a successful vacation rental project.
In the same vein, working with a property management company is a trade-off between time and finances. If you do choose to work with one, expect to put up higher nightly fees to cover this expense as well.
Lastly, reparations are an unexpected expense and a reality for vacation rental owners. Although you can deduct them from taxes, your budget still needs to be ready to manage them properly. Reparations cannot be included in the nightly fee per se, but you could increase the nightly fee by a small amount as insurance against this kind of expense.
Income Expectations
Rounding up every side of the expenses, you must have a calculated nightly figure for your short-term vacation rental. However, an important step is to compare this rate with those already charged by owners in your local market.
If your rates are high compared to what is being charged now, chances are that your vacation rental property may not be a good fit for the market. The same may be true for rates that are more or less in the same ballpark range because they would need a full occupancy rate to yield the expected results.
However, if the calculated rate is below the market standard, you can expect to turn a profit in most months, or at least cover your expenses with ease by raising it to the market price. You should not use the low calculated rate as a dumping strategy, as that would make a dent in your profit margin.
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Step 3: Consider Your Financing Options
Finally, after settling on a suitable vacation rental property, checking the local market for compatibility, and making sure that income and expenses calculations are sound, you will need to consider your financing options.
We will go through the most popular options for prospective property owners, highlighting the benefits and downsides of each. However, it is important to note that the main consideration is your own financial situation, determining which would be the most comfortable option.
Direct Financing
Although not many vacation rental owners fit these criteria, having the money to complete the purchase directly is the most time-effective, profitable route. No debt is incurred, no mortgage payments are required, and everything over basic expenses represents profit. If you have the financial capacity for this, we strongly advise in favor of it.
Conforming Loan
A conforming loan is one of the most popular financing options for vacation rental properties. Although the criteria is more demanding than for a primary residence, it should be a good fit for most real estate investors.
Having a credit score of 680 or above is enough to qualify you for such a loan. But you should also expect the requirement of making a down payment ranging from 20% to 25% of the vacation property’s total value.
Portfolio Loan
A portfolio loan is very fitting for investors which have other properties or assets in their portfolios. Borrowing against them presents a risk, but the requirements to qualify for it are notably more lenient than other financing routes.
In terms of portfolio requirements, owning multiple properties, or one multi-unit property should be enough to make this loan a possibility for you.
Multifamily Loan
A multifamily loan is generally used for vacation rental properties with multiple units, more often ranging from 2 to 4, or for apartment buildings with more than 4 units. Under this category, multiple types of loans can be found, such as portfolio loans, conventional mortgages, government-backed loans, and short-term multifamily loans.
Short-Term Financing
Real estate investors looking into this category are generally looking to secure interim financing until a long-term financing route is available. They can also be a good option for urgent purchases, such as a bargain vacation rental property with increased demand.
Bridge loans are the most popular option, securing the necessary cashflow for up to one year, but also coming with relatively high interest rates. Another option to consider is a hard money loan, financed by private investors, and coming with criteria that can either be better or worse than a bridge loan.
Investors looking into short-term financing are advised to strongly consider the ins and outs of their options before choosing to go down this route.
Conclusion
The bottom line is that vacation rental properties can be a very profitable endeavor for real estate investors. Along with the increased cashflow, owners will also have the flexibility of living in the property, using it for retirement, and taking advantage of tax deductions.
However, being more complicated than a classic long-term rental investment, the vacation rental strategy must be solid and double-checked to ensure the best performance possible. Above, we have mentioned the most important aspects that should be on every vacation rental investor’s checklist.
None of these steps should be taken lightly, as they are an integral part to the success or failure of your real estate project.
If setting up a sound vacation rental business is something you are not comfortable with, we can’t blame you. After all, expertise in real estate investments is a given for drafting a good plan. However, you don’t have to do everything by yourself.
What the Persinger Group Can Do for You
With more than 40 years of experience in the field and 7 properties under management, Persinger Group can help you fine-tune your investment strategy and offer professional guidance every step of the way. We make sure that our clients get the most out of their real estate investments and optimize their returns over the long term.
We can help you choose the best vacation rental property, make the right adjustments to enter the market and choose the most suitable financing option. All of this without needing to read countless real estate investment books and articles.
If you want to carry out your vacation rental investment stress-free, book a call or chat with us by visiting SmartMovesCall.com