Guide to Investing in Vacation Rentals
There’s a lot of appeal to investing in a vacation rental property. Not only does it provide a great spot for you and your family to travel, but it’s also an opportunity to diversify your investment portfolio and build wealth over time. Perhaps you’re looking into purchasing your first rental, or maybe you’re toying with the idea of investing in even more locations. Regardless, before diving into this quickly growing market you’ll benefit from exploring some of the nuances.
In this comprehensive guide, we’re breaking down the vacation rental investment process, including:
Getting your ducks in a row before you commit to investingFinding the perfect vacation rental propertyChoosing a lender and understanding the nuances of short-term rental (STR) financing Managing and maintaining your vacation rental
The Time to Invest is Now
Short-term rentals (STRs), including vacation rentals, are an exciting and rapidly growing new asset class. Airbnb and HomeAway, among others, are raising awareness of this increasingly popular, large opportunity. In fact, the vacation rental industry is projected to reach over $13 million in rental revenue in the United States in 2021, and the Coronavirus pandemic has only accelerated the industry’s demand.
Since vacation rentals are perceived by many as a safer travel option than hotels, a wider market of people are trying them, and liking them.
“For travelers, especially during this tenuous era where the very air and unclean surfaces can lead to hospitalization or worse, the individualized attention one might find renting from an Airbnb-type property rather than a monstrous hotel brand can bring some solace to travelers of every level of germaphobe.” – Travel Writer Michael Alpiner, Forbes
Alpiner further notes, “vacation rentals often give the traveler more space for less money overall” and the “convenience factor is substantial.” Statista highlights the tremendous growth of the market with powerful 2021 vacation rental statistics:
Vacation revenue in the US is expected to show an annual growth rate of 10.55%;The average revenue per user is expected to amount $299.96 in 2021; andVacation rental user penetration is 13.3% in 2021, which is expected to hit 18.1% by 2025.
Are You Ready to Invest in Short-Term Rentals?
The vacation rental industry is clearly booming, yet before diving in it is important to evaluate this strategy from different angles. Consider consulting your financial and other advisors for personalized advice.
Making Sure You are Financially Ready
Many new investors do not realize that a larger down payment is needed for investment properties than for owner-occupied homes. With consumer mortgages, you often can put down as little as 3%, yet with investment properties, you will likely need at least 20% of the purchase price.
You also are going to need to make sure you have enough money to fully stock your vacation rental property with furniture and amenities, in addition to any closing costs, insurance, vacancy expenses, and, of course, your down payment.
Weighing the Pros and Cons of Vacation Rentals as an Investment Strategy
Highly Lucrative: You may be able to generate higher returns with vacation rentals than long-term rentals. Typically, you will generate more rental revenue with a well-performing vacation rental. These higher revenues typically are partially offset by higher operating expenses.
High Demand and Marketing Potential: With the amount of vacation rental listing sites available, not only is it easy to market your property to potential vacationers, but there is also a growing amount of demand for vacation rentals.
High Appreciation Potential: Higher-priced properties in desirable locations tend to appreciate more than your run-of-the-mill long-term rental property.
Personal Use: Owners can use the property for a limited number of days each year without losing their tax benefits.
Regulations: Many cities and homeowner associations have regulations and even bans on short-term rentals. That’s why it is extremely important to check the requirements in your area before purchasing a vacation rental. Some cities, however, such as beach towns, are very supportive of short-term rentals. It’s always a good idea to confirm.
Off-Season: Vacation rentals tend to be seasonal. For example, summer is a great time to go to the beach, but November is not as big of a draw. Lodgify has great tips to increase off-season bookings.
Management: When you have guests checking in and out every three days, your short-term rentals need cleaning every three days. You also must get new guests their keys and collect keys from departing guests. It can be a lot of work and particularly challenging if you live in another city. That’s why a good property management company can be a game-changer.
Volatility: Consumer spending on travel and leisure is subject to changing economic conditions. Often during recessions, consumers spend less on travel and leisure. Plan accordingly to be able to handle an increase in vacancy in the event of an economic slowdown.
If you have fully evaluated the STR investment strategy and would like to move forward, here is our guide to finding, financing, and maintaining vacation rentals backed by our decades of experience and industry expertise.
Finding the Perfect Vacation Investment Property Location
Location, location, location. Finding an ideal location for a new vacation rental home is paramount, and the process can be quite involved. If you don’t already have a realtor in the areas you are looking, you should consider partnering with one. Realtors can offer great insight about the area and keep you top of mind when scouring properties for other clients. For your own due diligence, you should also conduct a geographical competitive analysis that compares the various markets you’re interested in.
Some vacation rental factors to consider:
Walk-ability to entertainment, food, etc. Occupancy rates, Current supply and demand in the area. Average revenue for rentals in the area. Crime rate
Evaluating the Revenue Potential of a Vacation Home
Once you have found a great vacation rental home, it is essential to evaluate the property for its income potential. We recommend using AirDNA to give you a clear picture of your expected earnings and vacancies. AirDNA has both free and paid tools that provide you insights on a single property’s:
-Average Daily Revenue
-Net Operating Income
You will also have larger market insights and top market listings at your fingertips. While we will always encourage you to consult your own advisors or personalized advice, AirDNA can provide you with extra insights into a property’s investability.
Finding a Vacation Rental Lender
Your financing options fall into three main buckets: conventional, portfolio and alternative. We’ll start with the simplest case.
If you are buying your first vacation property, you probably should start by looking at a conventional mortgage (Quicken, Wells Fargo, Chase, etc.) similar to the loan you have on your primary residence. To qualify, you’ll need to put 10%-20% down, have two to 12 months cash reserves (the amount depends on your credit score and down payment), and your monthly combined mortgage payments on your primary residence and second home (including taxes, insurance and any HOA dues) cannot exceed 45% of your gross monthly income. In meeting this requirement, the lender will assume you won’t generate any income from renting your new home. So you’ll need to meet the gross monthly income requirement without any rent credit. Plan on 60-120 days to close. Also plan on providing your full tax returns, a lot of income and asset verification documentation, and a variety of letters of explanation.
Portfolio and Alternative Mortgage Solutions
But what if you are self-employed, or maybe asset-rich but with little taxable monthly income, or maybe you already own a number of rental homes? In these situations, you should skip conventional and go straight to evaluating portfolio and alternative mortgage solutions. Portfolio is just a fancy way of saying, “community bank.” If you have good credit and have an ongoing relationship with a local bank, then you should talk to them to see if they might finance your new home purchase
Typically, these loans will be a bit more expensive in terms of fees and rate than a conventional loan. Also, they usually will amortize over 15 or 20 years rather than 30 years, and include a “balloon” payment after five or 10 years. But your local community bank will hold this loan in their loan portfolio (hence the name), so they can be a bit more flexible than a conventional lender. Again, plan on a lot of documentation and 60-120 days to close.
Alternative mortgage lenders typically offer a faster, smoother process with more approval flexibility, but at higher costs.