for Every Homebuyer
The Plan:
Short term rentals (STRs) are properties that have leases in place of fewer than 12 months. In reality, a vast majority of short term rentals in highly-trafficked areas with the best profitability tend to have "leases" that last a few nights to a week at most. Ever since the rise of short term rental listing services such as Airbnb or Vrbo, short term rentals have exploded in popularity and have transformed from niche passive income sources to thriving markets that enhance local tourism industries.
STR investments can be incredibly profitable, potentially generating double or triple the gross revenue of a long-term rental counterpart for the same unit. However, with such a high turnover of tenants, STRs demand significantly more attention unless you enlist the aid of a reputable and competent property management company (PMC). If you opt to manage the property yourself, you will be responsible for advertising, booking, and vetting potential tenants, keeping in compliance with local STR laws or codes, managing bookkeeping for operating expenses such as insurance, property taxes, and mortgage payments (if any), resolving customer complaints, and more. Yet the return on your investment with a well-situated STR makes the effort worthwhile.
Location will make or break your STR investment. While location is of vital importance to pretty much every real estate investing strategy out there, STRs just have that much more reliance on a smart choice of location. Ideally, you will want to base your STR operations in an area with a thriving tourist or travel scene that sees substantial year-round traffic. For example, a location that is only desirable in the winter and is desolate in all other seasons would make a poor investment option.
Process Breakdown
Step 1: Investor Obtains Financing Approval
Financing a short term rental property may be as simple as obtaining traditional financing for a second home. A second home can be rented out regularly, so long as the owner makes sure to reside in the property for at least 14 days of the year or 10% of the total time it is rented out, whichever number is greater.
A traditional mortgage for a second home will generally only be approved if the financed property is 50 miles or more from the owner's primary residence, and will have a minimum down payment of 10% for a single family residence. You are not required to own a primary residence to obtain second home financing if you rent a home in a different location or live with relatives. Traditional investment property financing can also be used, and it may be advantageous to do so, as 75% of future fair market rental income from the investment property can be used help qualify for the loan. However, keep in mind that even if the property will be used as a STR, you can only use long-term future fair market rent to help boost your personal qualifying income for mortgage approval. Traditional lenders do not allow future income at STR rates to be used for qualifying purposes, as they want to ensure your mortgage approval is based on conservative figures.
However, there are lending programs we offer that allow investors to utilize future STR income to qualify for a mortgage loan. This is a much more rare program and may not be available in all states.
Step 2: Investor Seeks Out Suitable Properties
Location is the vital organ of this whole operation and is the single most important factor in determine a suitable STR opportunity. There is far more to location choice besides tourism and travel concentration as well. Be sure to account for whether the area or the association your property is within (if applicable) allows short term rental operations to begin with. In many cities, the hotel industry has successfully lobbied policymakers to restrict STR operations so as to cut competition. If purchasing a condo or townhome for your STR strategy, which are very popular property types for STRs, ensure that the association permits leases shorter than 30 days, which usually tends to be the minimum lease duration if the association restricts STR operations. Understanding tenant's rights in the area of your purchase is also vital to running a successful STR operation, and even short term leases still carry tenant protections so long as they are paying for their stay.
The best STR locations are year-round places of interest. Areas along the coastline tend to be excellent choices for STR investments, such as San Diego in Southern California. Properties near major entertainment venues, such as stadiums or concert halls, can also be very attractive investments due to the constant influx of event goers. Just make sure that the events commonly hosted their are of the type that would draw a crowd that not only has a need for overnight accommodations, but can also reliably afford them (think adults versus juveniles). Locations without too much market saturation in the STR scene would also be ideal. However, as many desirable markets already have a high concentration of STR competition, you may have to settle for simply making sure that your listing stands out among a crowded market.
Step 3: Investor Submits Offer
Investors should ensure that, prior to submitting any offers on properties, they have thoroughly analyzed the location choice and have little to no doubt in the wisdom of their choice.
A reliable way to determine a great price for a potential STR is to see how the property in question would perform as a less profitable long-term rental. Should the property still manage to turn a profit after operational expenses, it will likely excel as a STR operation. You should always be sure to calculate your numbers conservatively, keeping in mind the likely rate of vacancy as your STR will not be occupied and producing income 24/7, as well as operating expenses such as mortgage payments, property taxes, property insurance, HOA dues (if applicable), PMC fees (if applicable), listing platform fees, cleaning/maintenance costs, etc.
Another way to determing the attractiveness of a deal would be to calculate its potential "cap" rate, or capitalization rate. The cap rate is determined by dividing the net operating income (profit after operating expenses) by the property's market value to determine a percentage. For example, a profit with a fair market value of $1,000,000 that produces a net operating income of $100,000 annually would present a cap rate of 10%. A cap rate of 4% or higher is generally considered a worthwhile investment, though this is subject to change based on localized housing market conditions.
Step 4: Investor Furnishes and Prepares Property
Unlike a long-term rental, where renting an unfurnished, undecorated property to tenants is the norm, STR operations are never left unfurnished. This is an additional operating cost upon acquisition of the property, as the required amount of furniture and decorations to make a STR appealing to a wide audience of vacationers and travelers will likely be significant (though mostly a one-time cost).
A sharp eye for interior design will be a valuable skill in this point of the process. The overall atmosphere imparted by a STR interior design scheme can result in referrals and 5 star reviews across the board, or lukewarm reception. An important thing to note that too many investors do not understand is that the design of the property must serve the tastes of the TENANTS, not yourself. What you find appealing may be perceived as dated or gaudy to visiting tenants. A second or third opinion here will never hurt.
Step 5: Investor (Or PMC) Markets Property on STR Listing Platforms
Now that your property is fully furnished and ready to receive tenants, you or your trusted PMC should immediately move to list the property on as many STR listing platforms as possible. Airbnb, Vrbo, and other major players in the STR listing scene will all make excellent choices to boost your visibility in crowded markets.
Summary
Pros:
Extremely high income potential, far exceeding the capabilities of long-term rentals for the same span of time.
Even in the event of poor tenant experience, leases are so short that any conflicts are usually resolved quickly, whereas long-term rental disputes can take months or even years.
STR purchases can be financed with traditional mortgages for a second home, which typically carries better pricing than purely investment-purposes home financing.
Cons:
Involvement level is significantly higher than a long-term rental due to the fast pace of tenant turnover. Property management is useful to mitigate this, but will reduce profits.
You have to be a landlord. This requires you to understand the landlord laws and tenant’s rights of the area you purchase in, unless you use a PMC.
STR occupancy rates are far less consistent than long term rental occupancies. External variables out of your control, such as local natural disasters or poor economic conditions, can reduce occupancy rates with little to no warning.
As STR operations are usually located in already desirable housing markets, the cost barrier may be very high for certain areas, reducing return on investment.
Conclusion:
Overall, STR investing is a strategy that presents the ability to rapidly accelerate passive income from investment properties to a degree that is unmatched by long-term rentals. Due to the rapid increase in home prices in recent years, however, opportunities to find reasonably-priced STRs have been dramatically restricted. Finding a great STR to acquire will take significantly more searching than it would have only 3 or 4 years ago, but locating and obtaining a productive STR can provide life-changing levels of passive income.