Owning a short-term rental property or vacation rental property is one of the best ways to generate a secondary income. When managed correctly, a short-term rental property can create reliable cash flows while also continuing to increase in value over time.
However, before you begin investing in and managing your own short-term rental properties, it is important to understand the market. By taking the time to learn about the ins and outs of short-term rental property management, you will be able to capitalize on your initial investment from the start and avoid some of the industry’s most common mistakes.
In this guide, we will answer some of the most common questions that property owners have about the short-term rental market. With the right information from the start and a solid understanding of market dynamics, you can become a successful short-term rental investor.
What is Defined as a Short-Term Rental?
A short-term rental is a property that is rented to guests for less than 30 days. Rentals can be either on a daily or weekly basis. Once a renter stays past 30 days, long term rental rules and regulations apply.
What is the Difference between a Vacation Rental and a Short-Term Rental?
The term “short-term rental” can be used to define any rental property whose guests stay there for a limited period of time. A vacation rental is a type of short-term rental with a few defining characteristics. Specifically, vacation properties are usually geared towards people who are actually on vacation. When compared to other short-term rentals, they will often be in vacation specific markets and include additional amenities such as added toiletries, snacks, and guidebooks. These properties will often be rented using Airbnb, Vrbo, and other vacation rental platforms.
Pros and Cons of Owning a Short-Term Rental
The demand for short-term rental properties has considerably increased over the past five years. Today, many people are looking for ways to become short-term rental property owners, both as direct investors and through various intermediaries.
Of course, as you will find with every major investment decision, there are both pros and cons to owning a short-term rental property.
The benefits of owning a short-term rental property include:
- Rental income cash flows (as long as you can keep the rental revenue above your total expenses, you can expect to generate cash flows)
- Continued growth in the property’s value (real estate, on average, has historically appreciated depending on location)
- Large amounts of leverage in the real estate market (you may be able to purchase a property with just a 10-20 percent down payment)
- Straightforward business model that can be easily replicated across different neighborhoods, cities, and properties
- Various tax benefits (deductions, credits, etc.)
- Ability to use it and stay in it when you visit the city or neighborhood
- Ability to limit exposure to financial and legal liabilities by establishing an LLC
At the same time, some of the most notable challenges that come with owning a short-term rental property include:
- Capital-intensive investments with low liquidity (if you change your mind, it will be fairly difficult to sell the property and get your money back overnight)
- Challenges dealing with guests, vendors, and potential employees
- Exposure to property taxes and other fixed costs—you’ll still need to keep paying these expenses, regardless of whether you have any guests
- Very competitive short-term rental market (you might have difficulties attracting guests at your target daily rates)
- Regular need for maintenance, upkeep, and other cost-creating needs
- Strict regulations that can vary by jurisdiction
- Profit and return on investment are not guaranteed
Taking the time to look at both the pros and cons of property investment will make it easier to decide if this type of investing is right for you. In general, short-term rental property ownership can be a profitable endeavor. But you will need to develop a detailed plan and take active measures to avoid common pitfalls. In some cases, hiring a short-term rental property management team can help you get better results.
How long can you stay in a short-term rental?
Every city has different rules. Some areas restrict stays to less than 30 days, while others allow stays that are several months long. It also depends on the kind of property; single-family homes can fall under different rules than multi-family properties.
How do I know if my city allows short-term rentals?
You can do a a Google search for your city's or metro's name and “short-term rentals.” Airbnb has gotten so popular that most local government websites devote a section of their website to licensing FAQs.
What kind of properties qualify as a short-term rental?
It depends on what your city allows. Some local governments allow whole homes to be leased as short-term rentals, while others restrict residents from leasing anything larger than a single room. In some cities, homeowners can rent out something as small as a renovated Airstream trailer or a “structure” in their backyard.
How to Evaluate if a Short-Term Rental is a Good Investment
In order to succeed in the short-term rental market, you will need to start by selecting the ideal property. Depending on local regulations (for example, Atlanta limits rental properties to two per owner), almost any residential-zoned property could become a short-term rental property. However, it is also clear that some properties will be significantly more profitable than others.
Finding the right property can ultimately make the difference between high profitability and financial losses. When comparing different short-term rental properties, be sure to keep the following factors in mind:
- Location: this is the most important driver of a residential property’s value. More than anything else, location will affect your annual appreciation as well as how many people will want to rent your property. Take a look at how property values range and change by neighborhood.
- Max, Min, Expected Revenues: in order to have a better forecast for your bottom line, you should look at three different revenue scenarios—the worst-case scenario, the best-case scenario, and the most likely scenario. This analysis will also make it easier for you to find your breakeven point.
- Seasonality: a lot of short-term rental properties experience significant demand shifts each season. For example, a short-term rental by a ski resort will typically rent for much more in the winter. Understanding seasonality can help you create a pricing structure that maximizes occupancy and total revenue.
- Fixed Monthly Expenses: there are some expenses you will have to pay regardless of your number of guests, including debt service, taxes, insurance, etc.
- Variable Monthly Expenses: other expenses will vary depending on how often your property is used, including (in most cases) utilities, maintenance , property management fees, etc.
- Rentability Expenses: when selecting a property, you will also need to account for investments that will make your property “rentable”, such as structural improvements, furnishings, repairs, special features, and others.
By taking the time to consider each of the variables mentioned above, you should be able to find a short-term rental that satisfies your current needs and goals. And by working with an abundance of data, you can develop a more realistic expectation for what your profits might end up being.
How Profitable Are Short-Term Rentals?
In general, short-term rentals are an attractive real estate investment class. The properties typically appreciate in value every year, assuming they're in a desirable and growing location, while also generating cash flows. The keys to turning a profit while owning a short-term rental include minimizing expenses, maximizing occupancy and average daily rate through utilizing a dynamic pricing structure.
What is a Good Return on Short-Term Rentals?
A “good” return for a short-term rental property will depend on its location, your exposure to risk, and the state of the market as a whole. However, generally speaking, most short-term property owners hope to achieve a return on investment of at least 5-10 percent per year. Some will have even higher expectations and will hope for closer to 10-15 percent, depending on a large number of factors. It is important to keep in mind that your “return” should account for all expenses and all sources of revenue that were generated by your property this year.
Financing a Short-Term Rental
Short-term rentals can cost as little as $100,000 on the lower end and more than $10 million on the higher end. This will definitely vary significantly depending on a large number of property and location factors.
Considering the relatively high price of these short-term rentals, many aspiring investors will need to obtain financing. In most cases, financing a short-term rental investment will be similar to applying for a traditional mortgage. Lenders will take a look at your current finances, your credit score, and various other factors in order to determine what interest rate and terms you can qualify for.
If owning the rental turns out to be profitable, you might want to consider paying down the mortgage or refinancing at a lower rate.
Growing a Short-Term Rental Business
Once you have successfully owned a short-term rental property, the next thing you will probably consider is how you can grow your business. After all, if you can reinvest the profits from the first property in order to secure another profit, the amount of money you end up earning will considerably increase.
Growing your rental business is something that will need to be done both carefully and deliberately. While failing to grow will cause you to miss out on future opportunities, growing too fast could trigger a future credit or liquidity problem. This is why having a well-founded business plan can be so beneficial.
When managed well, short-term rentals can be very profitable. But the operational aspect can be challenging and quickly wipe out profit if mismanaged. Those who are willing to take control of their operating expenses, implement an effective pricing and marketing strategy, and continue looking for opportunities for sustainable growth will be in the best position to succeed.