How To Invest In Short Term Rentals

Today we have another guest post from Dr. Jeff Anzalone, AKA The Debt Free Doctor.

Jeff is no stranger to ESI Money readers as he’s written several real estate-focused guest posts here. In fact, he’s written so many that I think of him more now as a real estate guy and less as a doctor. Hahaha.

His last post here was 10 Ways to Invest in Real Estate for Retirement in case you’re interested in reading that.

Today Jeff will be talking about investing in short term rentals.

This is a subject I’ve been interested in for some time. Obviously I’ve stayed in my fair share of short-term rentals over the years. But what really sounded fascinating (in a making money sort of way) was a friend told me he was making more on his short-term rentals in four months than he could make if he was renting them out for an entire year!

Now this was in Colorado Springs, so the location played a big part of his success, but even at that, I was still amazed to hear his results.

Since Jeff knows much more about this subject than I do, I asked him to talk with us about investing in short term rentals. What you’ll read below is what came from that request.

FYI, Jeff runs The Passive Investors Circle which includes investments in short term rentals.

With all that said, let me turn it over to Jeff to educate us all…

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When it comes to real estate investing, it can become confusing as to the best ways to invest and which asset class to choose from.

I started out investing in multifamily real estate syndications for extra income, as it was one of the more popular asset classes at the time. But the more I learned, the more I realized other ways to diversify especially when it comes to cash flow.

In some cases, short term rentals (daily or weekly) can provide even better cash flow compared to long term rentals.

When evaluating short-term rental properties (STRs) and long-term rentals (LTRs) side by side, STRs can often net 2x more vs LTRs.

Not only does this make STRs a great opportunity for everyday investors, but also for larger investment groups such as funds and institutional investors.

Maybe this is why we’re seeing trends, such as in the New York real estate market, where there’s more Airbnb listings than apartments to rent.

In this article, we’ll discuss:

• What is a short-term rental investment
• How they work
• What to know before considering to invest
• How to invest in STRs

What is a Short Term Rental (STR)?

A property is considered a short-term rental (STR) if rented on average for less than seven days at a time. If you keep this average to 7 days or less, then you can take advantage of the short-term rental tax loophole.

STRs, also known as vacation rentals, are usually rented out for vacation or business trips.

And with the advent of online platforms such as Airbnb/VRBO, it’s never been easier for virtually anyone with a second-home, vacation homes or rental property to use as a short-term rental.

The main difference between short-term vacation rentals, motels and hotels, is that STRs are similar to regular homes or condos. How? STR guests have access to kitchens and laundry rooms, which allows them to cook and do laundry on the property.

This is especially helpful when traveling with a large group of friends or family.

Also, some people who have short-term rentals only rent out a part of their house. In fact, some city ordinances and laws say that the owner of a short-term rental must live there while the guests are renting.

As a side note, STRs usually aren’t allowed to have guests who stay at the property for more than 30 days.

Are Short-Term Rentals Profitable?

Short-term rentals can be very profitable, especially now that people are preferring to stay in them over hotels.

As with any type of real estate, there are a handful of variables that can affect a short-term rental’s profitability that must be taken into account.

One of the most crucial is location. If the rental isn’t located in a desirable area, then it will be difficult to obtain high occupancy rates.

The next factor to consider is the number of up-front costs and maintenance services that will be needed.

When you compare two identical properties in the same area, a short-term rental can often generate at least two to three times the rental income of long-term rental properties.

Also, rentals during high demand periods, such as holidays, are a great inflation hedge because they can offer more opportunities to charge higher rates.

Furthermore, if you want a vacation home, STRs can be used to offset the costs involved with a second home.

How To Invest In Short Term Rentals

If you’re considering investing in STRs, you must meet a few requirements.

Let’s go through all the fundamental first steps, as well as the process for beginning a short-term rental business that is dependable and successful.

#1. Goals

The first stage in making any investment is setting goals so that you can take the necessary actions to achieve them.

In regards to the short term rental market, you must decide if you:

• want a vacation home but need the rental income to cover costs before retiring
• are looking to build a cash flowing rental portfolio (whether active or passive)

You’ll be able to decide what to do next once you’ve answered these questions.

For example, if you want a second home, you’ve got to figure out “where do you want to retire” and search for properties there (The Villages anyone?) 🙂

If investing is your main goal, you should focus on finding the best investment property in desirable places that give you the best return on investment (ROI).

#2. Assess your purchasing power

The next step is to determine how much purchasing power you have. At this point, it would be helpful to consult with a CPA that has a real estate background.

One of the first questions you must answer is how much house you can afford.

Most of the time, you’ll need to put 20–25% down on the property. You’ll also need money for closing costs, which can be anywhere from 2-4% of the purchase price.

Here are a few more costs to think about:

• Renovations and improvements to a property
• Fixing or upgrading home features (i.e. appliances)
• Furnishing costs

As you can imagine, these costs can add up quickly to the tune of tens of thousands of dollars.

So it’s a good idea to make an all-in number that you can afford.

#3. Research markets

You have two main tasks to complete as you research STR property:

• The first involves market analysis, as you should find out where short-term rentals are most profitable. Certain markets are characterized by high pricing, while others are marked by high prices only at certain times of the year. In some markets, rents might be lower, but occupancy rates might be more stable all year long.
• The next task has to do with the area’s STR regulations, as all vacation/STR markets are NOT created equal. There are some neighborhoods where short-term rentals are prohibited.

It’s usually a good idea to hire a local agent well versed in regulations in their area market who can help identify properties as they know the ins and outs of the market you’re looking in.

Next, you should research:

• registration requirements
• permit fees
• obtaining a business license
• if there’s a need to collect a lodging or rental tax to the local municipality

You’ll also need to understand what a good investment is in the rental markets you’re looking at in terms of:

• Average occupancy
• Average daily rates (ADRs)
• Operating expenses
• Seasonal rates
• Biggest draws to area
• HOA Term

Do your own due diligence by researching sites such as Airbnb/Vrbo to determine:

• property taxes
• insurance
• rental/occupancy rates

#4. Calculate the numbers

Running numbers is essential in the STR market and luckily there’s plenty of resources for real-time data such as:

• Airbtics
• Vrolio
• AirDNA
• Roofstock STR Marketplace

Some of the key metrics used to measure financial performance include:

• Average length of stay (ALOS)
• Cash flow
• Occupancy
• Average daily rate (ADR)
• Revenue per available room (RevPAR)
• Cap rate
• Annualized return

After you’ve identified a few STR possibilities, it’s time to move on to step #5.

#5. Buy the property

While you’re searching for the ideal property, you’ll want to start the financing process and enlist the services of a lender.

Once you’re ready to move forward with purchasing a property, it’s a good idea to perform a few critical calculations.

At this point, you’ll know details such as:

• property taxes
• insurance premiums
• typical energy costs
• other fixed expenses

To make sure you can afford the mortgage and other expenses, compare this to the rent rates and days available.

#6. Assemble a team

It’s essential to assemble your team, which should include your:

• accountant
• real estate agent
• a property manager (if you choose to go that route)
• cleaning crew

If you decide to continue expanding in the future, consider adding these as well:

• attorney
• bookkeeper
• personal assistant
• additional employees

Adding all of these specialists to your team will keep you from making rookie mistakes.

#6. Closing

When an offer is accepted, you can start performing due diligence by doing an inspection. If everything checks out, the lender will start the process of approving the loan.

Depending on the STR laws of the state it’s in, the closing is usually done by a real estate lawyer or title company.

Once this is done, you’ll be able to take possession of the property on the day of closing and start getting rental income on the same day.

It’s a good idea to make sure that all of the reservations made before the purchase have been given to you. You’ll also need to make sure that any down payments or advance deposits are listed on the closing statement.

#7. Assemble a team

It’s essential to assemble your team, which should include your:

• accountant
• real estate agent
• a property manager (if you choose to go that route)
• cleaning crew

If you decide to continue expanding in the future, consider adding these as well:

• attorney
• bookkeeper
• personal assistant
• additional employees

Adding all of these specialists to your team will help you from making rookie mistakes.

Is a Short-Term Rental Property A Good Investment?

STRs have several benefits making them a great investment to consider adding to your portfolio.

5 Reasons to consider investing in short term rentals:

#1. Increased earnings

A friend of mine has a single family home with long-term tenants in the neighborhood where I grew up earning $1,100 per month. He’s now turned it into a short-term rental earning $3,900 a month.

If you’re able to find a home in a desirable location, then consider turning it into a STR as it will typically earn more than a long-term rental.

With STRs, you’re also able to charge more during peak seasons (such as holidays) when demand is higher earning extra money to help even out any lower occupancy times.

#2. Flexibility

With STRs, you’re the one that has the control to decide when to rent it out.

For example, if you have a beach house, then you can block off times during the year when it’s only available for personal use.

If potential guest wants to stay for an extended period of time, you can change the rental rate to make it more competitive.

#3. Easier maintenance

STRs are cleaned more often vs long-term rentals which allows you to identify maintenance problems before they go on for too long.

Also, the tenants pay a cleaning fee which allows you to keep the property in good shape without having to come out of pocket for it. If they break someone or spill wine on your rug, their credit card is on file to bill them for the damages.

#4. Appreciation

In general, real estate appreciates or goes up in value over time, which is one of the reasons I started investing in the first place. Similar to a stock or mutual fund, typically the longer you hold property, the more it’ll be worth when it’s time to sell.

As a side note, the property’s location will determine the rate of appreciation, whether fast or slow, to see a significant difference in the value.

#5. Tax benefits

Most people start off investing in real estate for the passive income, but continue for the tax benefits it brings. And one of those benefits is depreciation.

Depreciation is a gift (tax strategy) given to us by our friends at the Internal Revenue Service (IRS).

This unique strategy allows you to write off the value of an asset over time.

For owners of residential real estate, straight-line depreciation can be used to depreciate property over 27.5 years.

If you don’t want to wait that long, you can obtain a cost segregation study to accelerate depreciation over shorter time schedules of 5, 7, and 15 years.

To learn more about how this works, check out this video:

Bottom Line

As you can imagine, there’s much more detail that goes into STR real estate investing. There’s both advantages and disadvantages to STRs and LTRs.

Another important point to make is whether you want to be actively or passively involved with the investment process.

If you’re a busy professional like me and members of our Passive Investors Circle, then your time is limited.

It’s for this reason that I partner with others to make this sort of investing extremely easy.

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A few thoughts from me on some things said above:

Also, rentals during high demand periods, such as holidays, are a great inflation hedge because they can offer more opportunities to charge higher rates.

I had another friend (not the one I mentioned in the introduction) who also lived in Colorado Springs. He used to rent out his home for a week during graduation at the Air Force Academy every year.

He made enough to take his family to Disney for that week PLUS have a few thousand dollars left over! Not bad!

STR guests have access to kitchens and laundry rooms, which allows them to cook and do laundry on the property.

This is huge for us. Having a washing machine and dryer means you can travel light and simply wash your clothes versus having to pack everything you wear ONCE for an entire trip.

When we’d go to Grand Cayman (even for 10 days) we’d all simply travel with carry on luggage. It was very nice.

For example, if you want a second home, you’ve got to figure out “where do you want to retire” and search for properties there (The Villages anyone?)

FYI, most of the homes rented in The Villages would not qualify as STRs as, by definition, and STR is: “A property…rented on average for less than seven days at a time.”

Most of the homes in The Villages are rented for months at a time. January-March is prime time and the rent rates amount to a king’s ransom. In my estimation, an owner can pay for his entire annual costs of home ownership (insurance, taxes, maintenance, fees, utilities, etc. — not a mortgage) by simply renting out his home for those three months every year.

To be clear, I am not invested in any STR syndications and not invested with Jeff as of this writing. This is not any sort of commentary on him or his offerings. For me, my timing and objectives have just never lined up with something he had available. Just want to be open about that and remind you to always do your own research so you’re comfortable with any investments as well as sure that they meet your financial goals.