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Ask Brian: What Should I Know Before Investing in a Short-Term Rental?

By Brian Kline | January 24, 2022
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Ask Brian is a weekly column by Real Estate Expert Brian Kline. If you have questions on real estate investing, DIY, home buying/selling, or other housing inquiries please email your questions to [email protected].

Question from Mary in CO: Hello Brian, I’ve had rental houses for several decades while also owning a small retail business. I have a sports equipment store that simply can’t compete with online stores. Early in the pandemic, I tried moving more of my sales online but without much success. Now, I’m ready to sell the store and go into retirement or at least semi-retirement. My long-term plan had been to retire by seller-financing my store combined with the income from my rental houses. I do not own the building where my store is located, and no one is going to buy out my poorly operating store. The lease expires in eight months and I’m going to let it go. The rental house income isn’t enough for me to retire in the way that I want. But I do have a lot of equity in the four houses. I’m thinking about selling the rental houses and transitioning to short-term rentals because the profit margin is said to be so much higher. Of course, I’m doing a lot of research before making the decision. What insights can you share to help me decide if this is the right move for me?

Answer: Hello Mary. The first thing that I’ll say is that short-term rentals (STR) are proving to be very profitable in some specific areas. If you decide to go in this direction, the best location might not be in your hometown. You should have an open mind to look at places that have a history of being the most profitable. STRs are not an entirely new rental category. People have been renting out single-family homes and condominiums as vacation rentals for many years. What has changed is that brands like VRBO, HomeAway, and Airbnb have exploded over the past 10 years. According to a report from AirDNA, the U.S. hit a new booking record every month in the first quarter of 2021 and STR occupancy rates continue hitting new highs. The current prediction for occupancy is expected to average around 58.9% with a daily rental rate of about $248. That comes to just under $4,400 per month.

However, I’m sure you are aware that the high turnover also means higher expenses. Mary, if you’re thinking about retirement and want a passive income you will need the services of a good property management company. But before you get into that...

The place to start is by researching and analyzing local factors like the average occupancy rate, price per night, and cost of properties before deciding which investment makes the best financial sense. When it comes to an STR, there are also other factors to consider. For instance, there tend to be two distinct types of customers in the STR market. Businesspeople need to be close to metro centers and vacationers prefer tourist attractions such as beaches, mountains, and national parks. I’m going to focus on the vacation side because the business side faces stiff competition from top-end hotels in metro areas and many metro areas have enacted stiff regulations limiting where and how STRs can operate.

The vacation market can be further segregated into destination vacation markets and regional drive-to vacations. In any case, chances are that the best markets are not in your hometown. Also, something to be very aware of with vacation rentals is that occupancy can be seasonal.

Major destination vacation markets can be highly lucrative. Places like Hawaii, Disney resorts, the Poconos in Pennsylvania, beach resorts like Surfside Beach in Texas and the central coast of Oregon, ski destinations in Colorado, and many others that are less expensive. These places have stable regulations for short-term rentals because the economies have been dependent on tourists for decades. Still, you want to do your research because affluent permanent residents have enacted some strict restrictions limiting the neighborhoods where STRs are allowed.

Destination vacations are also susceptible to economic conditions. These areas are highly profitable during good times but also suffer significant slowdowns when vacation travelers tighten their belts. That and other reasons can make drive-to vacation destinations a better investment.

Just like national destination vacations, drive-to vacation destinations have almost no industry other than tourism. That makes for stable STR regulations. However, drive-to destinations are much more affordable, faster, and easier to get to. They do better during economic slow times. These also tend to be in small towns with much lower real estate costs. They are so dependent on tourism that STR regulations tend to be very accommodating in these markets, but of course, you should still do your research.

With drive-to destinations, you may have to balance occupancy rates with high rental income. The national destinations do charge more per night, but drive-to destinations are much more recession-resistant (higher occupancy).

Mary, STRs are one of the most regulated sectors of the real estate industry. But don’t let a fear of regulations keep you out of a highly profitable real estate market. There are serious advantages.

  • Monthly income can be several thousand dollars more than a long-term lease or month-to month-rental.
  • High income makes professional property management more affordable while collecting a profitable passive income.
  • You don’t have long-term tenant problems.
  • These are direct cash transactions without credit and background checks.
  • You collect the rent upfront when reservations are made. No late pay or failing to pay.
  • There are reliable marketing platforms such as maximize STR bookings from the beginning.

But Mary, plan before you leap. Many STRs are luxury properties that could cost more than an all-cash purchase after you sell your long-term rentals. You may need to borrow at the time you are retiring. STRs have other differences that you won’t typically find with long-term rentals. Make an honest calculation of the income you will earn and the expenses you will pay that your long-term rentals don’t incur.

  • A marketing platform such as s Airbnb collects a commission based on the rent or an annual fee.
  • Property management costs include frequent cleaning and stocking fees.
  • You’ll need short-term rental insurance.
  • Possible local fees on short-term rentals.
  • Furnishing the property upfront.
  • You pay the utilities, not the tenant.
  • Often, TV entertainment packages are included. You may need to provide a high-end entertainment system.
  • Consumables like toilet paper and toiletries.

STRs can offer a different path to retirement with a high-income stream. But it will take additional research and planning to understand this alternative real estate investment. But once a system is in place, STRs could be the profitable asset you are looking for.

A ton more information could be included here. Please add your comments.

Our weekly Ask Brian column welcomes questions from readers of all experience levels with residential real estate. Please email your questions or inquiries to [email protected].

Brian Kline has been investing in real estate for more than 30 years and writing about real estate investing for seven years with articles listed on Yahoo Finance, Benzinga, and uRBN. Brian is a regular contributor at Realty Biz News
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