Advertiser Disclosure

Investing in Short Term Vacation Rentals

Owning real estate has historically generated impressive returns for some wise (and fortunate) investors. But how do real estate investments compare to other investments available in the stock market?

Comparing a long or short-term investment in real estate to a stock market investment can be a bit tricky. This is mainly because it can be challenging to apply individual investment results on a reliable scale with enough breadth to generate statistically significant conclusions.

Real Estate vs. Stock Market Investing

First, over the long haul, it is noted that stock values tend to increase more quickly than other long or short term real estate investment opportunities.  As the below graph highlights, the S&P 500 index fund has historically averaged returns in the 9–10% range each year.

Source – forecast-chart.com

The actual annual returns from 1951 and forward can help clarify the cyclical nature of the overall economy and the resulting changes to annualized returns for stock market investments.

Source – forecast-chart.com

In comparison, median home values – that have been adjusted for inflation, have, according to the United States Census Bureau have nearly quadrupled over the past six decades.

The Census Bureau also offers a state-by-state chart of median home values from 1940 through 2000 – when adjusted for 2,000 dollars. The census data reveals that each decade saw an increase in median home prices; the fastest rise was seen during the 1970s, with the slowest rise in home prices in the following decade of the 1980s.

After adjusting for inflation (and other relevant factors like a marked increase in average home size), the average home price has risen by 1.5% each year.

Source – storagecafe.com

However, the location of the property will also modify the price changes.

Although historically, many of the best real estate investments have come from maintaining real estate investments in a long-term portfolio, some of the best real estate investments and opportunities in the modern real estate world can be found by smart investors who have answered these questions regarding short term real estate investments before making an uninformed investment/decision –

  • Are short-term vacation rentals located in some of the best real estate investment cities?
  • What is short-term rentals a smart investment strategy?
  • Do short-term vacation rentals San Diego or short-term vacation rentals Florida offer investors the greatest chances of success as results vary by location?
  • Where can I find the best real estate investment states that offer above-average returns for both long and short-term investment options?
  • What are the expenses associated with insurance for short-term vacation rentals Florida – or other locations?
  • Are short-term vacation rentals a smarter investment than long-term rentals?

And while dollar for dollar, it appears, in fact, as stock investments outpace some of the best real estate investments, the reality is short-term vacation rentals, and other investments offer other less tangible benefits. These are discussed below.

The Best Real Estate Investment Options Offer Stronger Potential Returns

Real estate values have historically kept pace with inflation, however, measuring a short-term rental investment opportunity offers investors other benefits to choosing to own one of the many short-term vacation rentals Florida or other southern and sunny locations have to offer.  

Leverage is an important financial concept and essential to understanding that, as an investment technique, it helps determine which of the available best real estate investment cities or the best real estate investment states offers the best potential returns.

Leverage is the financial tool using borrowed funds to finance an investment, which is part-and-parcel of most long or short-term investment options in real estate. Ironically, leveraging in stock investments is viewed by many as irresponsible, whereas leverage is the technique most often used to purchase one of the many available short-term vacation rentals in San Diego or anywhere else along the Pacific Coast.

And while this comparison is relevant and essential, it’s challenging to compare two investment strategies without considering the fact that real estate investments –

  • Offer greater chances for impressive potential returns than stocks like –
    • Price Appreciation
    • Rental Income
    • Tax Benefits, to name a few.

How to Invest in Short-Term Rentals

Short-term rentals are notoriously known as one of the more prudent ways to hedge disruptions to income due to stock volatility. In the glass offices on Wall Street, this is known as diversification. The global vacation rental market is likely to have a CAGR (Compound Annual Growth Rate) of around 7%, which translates to about a $62 billion growth between 2020 and 2022. [ See Technavio.com 10/2020 Report]

With Airbnb & VRBO (among others) creating mainstream short-term rental options unlike anything before it – short-term rental investments remain primed for steady growth. The 2020 pandemic has unexpectedly shifted consumer behaviors regarding rental unit preferences, which needs to be considered moving forward.

Rather than getting tied into a long-term rental contract, property investors can capitalize on unique local demands for temporary, college, or vacation rental housing, to name a few types of short-term rental investments.

Primarily, the income generated on a per month basis for short-term rentals is typically higher than the rents charged for longer-term rentals. Although cleaning and upkeep costs may increase for short-term rentals (after each tenant) – and depending on the location or the season, renting a short-term investment full-time may be difficult but not always necessary.

Learn the Legalities & Keep On-Top of Recent Legislation

Rental investors – short or long-term, must ensure their actions remain within the confines of both local and state laws. However, for those interested in short-term rentals, it is especially critical to understand how these relevant regulations can shape the short-term rental market. As the short-term rental has grown beyond what was once viewed – a cottage industry, legislators have begun to listen to the neighboring residents and the local hotel/motel industry to regulate the industry.

With the potential costs and ongoing changes to regulations, it is critical to have the knowledge required to make smart short term rental decisions.

Short term investments in rentals are quite lucrative if local legislators have not put a stranglehold on the market with laws making it challenging, if not impossible, to rent on a short term basis. Some typical regulations may –

  • Only allow specific types (entire properties?, rent a room?). This can be further complicated by how a short term rental investment is defined by local authorities.
  • Limit the rentals to certain days of the week
  • Limit the number of rental units in any one location
  • Mandate minimal rental arrangements that can’t be shorter than a month
  • Require a license to operate within the law
  • Have zoning laws that apply
  • Require the property to be a primary residence, to name a few.

Because a legal tug-of-war is currently being played out – between those who wish to allow property owners their right to do as they wish and those who wish to restrict the number of short term rentals, for other reasons.

Research the Market Carefully

The triple-location message is particularly true when it comes to considering short term investments in rental properties. The fundamental business metric to balance would be to shoot for a combination of a property that offers an appeal to short term renters and profitability.

Financial analyses can use rental comparisons and expected expenses – using estimates for nightly rates in the area to determine if the projected Return on Investment (ROI) meets the investor’s requirements.

What is the Bottom Line?

Do your due diligence upfront and remain aware of the relevant law. Analyze the financial scenario using conservative numbers – not only best-case scenario numbers.

PRO-TIP – Taxes are a critical part of remaining legally compliant. The complexity of these changing laws makes it a prudent idea to consult with a tax expert.

Calculating Rental Yield and Returns

Rental yields are the financial measurements (expressed as percentages) used to determine the revenue generated by an asset is a measure of how much cash an asset generates each year based on the asset’s value/investment.

GROSS YIELD

Gross yields are calculated used overall revenue – without consideration for expenses or vacancies. Gross yields are easy to calculate and give a quick comparison for properties with varying rents and values.

HOW TO CALCULATE A GROSS RENTAL YIELD

There are two simple mathematical steps required to calculate the gross rental yield –

  1. Divide the property’s Annual Rental Income by its current market value.
  2. Then multiply this result by 100 to convert it to a percentage.

GROSS YIELD EXAMPLE

RELEVANT DATA –

PROPERTY VALUE OF $600,000

EXPECTED GROSS RENT $3,000 A MONTH

  • Yearly Rent is $3,000 x 12 = $36,000
  • Gross Rental Yield is ($36,000 /$600,000) x 100 = 6% Per Year
NET YIELD OR RATE OF RETURN (ROR)

A net yield offers more financial insight into a property as an investment as it accounts for the property’s expenses – mortgage payments, taxes, insurance, maintenance -plus anticipated allowances for vacancies.

HOW TO CALCULATE NET RENTAL YIELD

There are three simple mathematical steps required to calculate the gross rental yield –

  1. Subtract Annual Expenses from the Property’s Annual Income to calculate Net Rental Income.
  2. Divide the Net Rental Income by the Property value.
  3. Then multiply this result by 100 to convert it to a percentage.

NET YIELD EXAMPLE

RELEVANT DATA –

 PROPERTY VALUE OF $600,000

EXPECTED GROSS RENT $3,000 A MONTH

YEARLY EXPENSES & VACANCY ALLOWANCE – $6,000

  • Net Yearly Rent is $3,000 per month x 12 = $36,000 – $6,000 = $30,000 Per Year
  • Net Rental Yield is ($30,000 /$600,000) x 100 = 5% Per Year

What is a Good Rental Yield?

So, the $64,000 question – what is a good rental yield? What is the rental yield one should aim for? Like most investments, there is simply no universal answer as an investor’s priorities and criteria are dependent on many factors. In an ideal rental market, a net yield of seven or eight percent would be quite appealing, although this is not the only metric to consider.

A high rental yield is certainly good, but smart investors consider the relevant facets of their investment to help facilitate the best returns from their investments.

Occupancy Rates: Is the unit located in an in-demand, desirable location?

Holding Period: How long do you, the property investor, intend on holding onto the investment?

Capital Gains: What capital gains can be expected, and are they taxable?

Investment Strategy: How does this rental unit fit into one’s long-term financial goals?

Risks: Are there any local development projects that may impact the value/appeal of the property or cause functional obsolescence? Is the state ready to implement tight rental regulations?

Increasing Cash Flow to Reach a Preferred Net Rental Yield

  • Try to select properties located in a high-demand rental market.
  • Be certain to offer — professional property management services to your guests/renters.
  • Invest in the property wisely, which is really another way to say it takes money to make money. This can be done with a fresh coat of paint which may increase a jump in the unit’s premium price point
  • If allowed by law and physically feasible, consider renting each room separately.
  • Create effective marketing plans & efforts as this is one way to reduce or avoid vacancies (reduced rental revenues).
  • Be sure to use each of the property’s assets when considering rental options – other assets may include laundry facilities or parking lot fees where parking spaces are at a premium.

Preparing Your Listing

Understanding where and how to list one’s short term investment rental is as important as finding the right investment. The short term rental market is a new game in the real estate market (in relative terms), so it pays to stay abreast of the many innovative real estate minds creating applications and websites to help you increase your unit’s exposure and, thus, profitability.

AIRBNB 

Airbnb was an original room sharing site developed in 2008 with its initial target market aimed at younger audiences. Since, it has grown to have more than a million listings across the globe, with more than 25 million guests!

Airbnb uses a business model in which it earns a commission only when a guest makes a booking. All transactional information is managed through the Airbnb site. Airbnb is streamlined and a breeze to use for both hosts and guests.

All communication must be managed through the site until a guest has made an official booking. Small investors will likely be competing commercial renters – especially in the more popular tourist attractions and larger urban areas.

VRBO

VRBO was established in the mid 1990s as a HomeAway member but was bought by Expedia in 2015. VRBO is also an easy-to-navigate site, with helpful toolkits, although its payment system can be somewhat complicated to some.

VRBO non longer offers annual subscriptions (since 2017), which also eliminated pre-booking contact with potential guests.

FLIPKEY

FlipKey is a vacation rental website hosted by TripAdvisor. FlipKey claims to have more than 250 million visitors to its 20+ sites each month. FlipKey offers a well-crafted, strong search engine with many filters to refine rental home searches.  

HOUSETRIP

Housetrip (another TripAdvisor Site) was founded in Europe in 2010 – with hundreds of thousands of homes advertised across more than 20,000 international locations. Fees are paid by the host and guests. The site is well designed to allow for search refinement in terms of the price of a home (quoted in pounds!), the type of home, the size of the home, the number of bedrooms or bathrooms, and more.

ONEFINESTAY

Onefinestay was established in 2009. Several years later, it became a member of the AccorHotels family. Onefinestay lists thousands of rental homes in major cities like LA, Paris, New York, and Rome, among others. The focus on this site is LUXURY – and provides services during the guest’s stay.

Representatives from onefinestay work closely with each host and each of the guests (meeting them in person when they arrive, for example). Their services include the professional cleaning of the home (including the provision of luxury linens & towels, if required) before the guest(s) arrive and then again after the guest departs when their stay has concluded.

SABBATICAL HOMES

Sabbatical Homes was established in 2000 and developed to target those in the education or academic community – although anyone may list their home for short-term rental. This site also offers –

  • Home exchanges opportunities
  • Home sharing options
  • House sitting availability, among other options.

Many guests or renters in this market seek rental units for one to six months, but it is noted that Sabbatical Homes is simple and easy to use, and available to everyone – independent of their work setting.

CRAIGSLIST

This classified advertising site leaves the host and guest to operate on their own – independent of any services or guarantees. The lack of bumpers makes Craigslist a favorite for scammers. If you plan to use this for your rental unit, NEVER share direct email addresses, phone numbers, or the property address until you can vet the other party.

Watch For New Listing Sites

As the short term rental investment market evolves, it is important to stay current with new websites designed for short term rental investment owners. Many business entrepreneurs recognize the size of this yet-to-be-met market demand, so there will likely be well-funded and managed sites implemented each year, offering new and improved services or expenses.

Managing Short-Term Rental Properties

Short term rental investors will soon learn that while short term vacation rentals may generate revenue to cover costs, the property’s maintenance and cleanliness is a time-consuming requirement. So, the next important question to consider as an owner of a short term rental property is –

Does it make fiscal sense to pay a professional to manage the property – freeing up your valuable time?

In one respect, if you have successfully rented a property that –

  • Brings in extra income consistently while covering the cost of maintaining the property,
  • Will likely appreciate in value while renters and guests cover the costs of maintaining the property.

However, these financial benefits provided to a short term vacation rental owner require a property owner to be responsible for –

  • Rental inquiries – before, during, and after the booking
  • Bookings
  • Cleaning
  • Maintaining the interior of the home, plus the yard/pool/hot tub, if applicable
  • Collecting rents
  • Repairing damages
  • Managing online reviews, plus many other unexpected dilemmas along the way

The decision to employ a property management company is generally two-fold – 

  • Will the property’s financials support another expense against the income generated by the rental unit?
  • Does the property owner believe their time is better utilized in other endeavors, which can only be available with the use of a short term rental management company?

Short-Term Rental Property Management Companies

The short term investment market’s success has created the need for a new breed of specialized property management companies – those that focus primarily on short term rentals! These newer property management professionals are experts at short term rentals rather than the more traditional property management companies that tend to focus on larger commercial properties (like a gated community, for example) that often-included long term tenants/renters.

Property management companies that focus specifically on short term rentals must not only consider the physical aspect of property management (think repairs, landscaping, and maintenance, etc.), but they must also offer the aspects expected by short term or vacation rental users, like hospitality issues –

  • Managing bookings
  • Managing guest check-ins on arrival and check-outs upon departure
  • Help ensure the best reviews from guests

Short term property management companies offer services on a more personal scale than traditional companies. The most expensive of these serves are those that offer turnkey management – from marketing to maintenance and everything in between.

These managerial services for short-term rentals vary greatly in price – as great as the services they offer. Clearly, the high end of the spectrum will offer the most in the way of services and customer service but will likely take the largest bite from your budget.

Related:

How to Get Started with Investing

Is Buying Land a Good Investment?

Best Passive Income Ideas