5 Things to Consider Before Investing in a Short-Term Rental (Post COVID-19)
As economies begin to open up since COVID hit, many investors are flush with cash and are looking to grave dig (ie invest in distressed assets). No doubt, one of the hardest hit asset classes during this pandemic has been hospitality - hotels and short-term rentals.
While there is definitely opportunity in the short-term rental market, this piece serves as a “think twice” before you decide to put your hat in the ring. While the core elements of real estate investing and management hold for a short-term rental, it is now evident that short-term rental / vacation rental investing requires a larger risk appetite.
As an example, say you have a property that you think is ideal. What types of travelers frequent this market, area, property type? How likely is demand to decrease if the market turns? How confident are you that you can generate consistent profits? How lean are your management and operations to maximize your profit margin in case of a downturn?
These are important questions because any two people can purchase the same short-term rental asset. And both people can have completely different property and revenue results.
Here are 5 things to consider before investing in a short-term rental:
1. DO YOUR HOMEWORK. MOST REALTORS DON’T KNOW THE SHORT-TERM RENTAL MARKET.
Unless you are in a classic vacation rental location (ie Smoky Mountains, Orlando), most realtors do not fully understand the vacation rental business. It’s new and it’s not their core business. The majority of their business is selling homes to families with a concentration on school district or home appreciation. While appreciation can never be overlooked, short-term rental investments are centered on cash flow.
To help you filter the best realtors to work with, we recommend doing research on your own. Do you due diligence on websites like AirDNA and Mashvisor to see what areas and homes generate the most profits. This should be done with a 2-sided model - during good times and during bad times. Once you have an idea of what this looks like, you can begin to have conversations with realtors.
Ask realtors what they know about short-term rentals in your intended market. Do they have experience selling properties with short-term rental potential? Do they have clients or friends who operate short term rentals. Your ideal realtor can discuss supply and demand, regulations, inbound tourism, seasonality and the importance of location for different traveler demographics.
Do your upfront research, and once you have a baseline for communicating with potential realtors you can see who fits the mold. Make it clear you are focused on generating profits & show them your data research so they know what this looks like.
2. IDENTIFY YOUR IDEAL PROPERTY, BUT HAVE A BACKUP PLAN(S) IN CASE SHORT-TERM RENTAL OPERATIONS DO NOT WORK OUT
A property that has solid short-term rental history, has a list of previous guests for remarking purposes, and may come with reservations already in place can be seen as a valuable asset, but this can change swiftly once you take over management.
It helps to have 2 back up plans. 1) What can you expect if you decide to rent the home as a long-term rental? and 2) Can you flip the property quickly if things don’t work out? Number 1 is most important for your underwriting because if your property does not pencil out with long-term rents, than you are taking on much higher risk.
3. SHORT-TERM RENTAL COMPLIANCE IS A MUST
As Airbnb has become more popular across the world, municipalities have created various “solutions” to address their market. It is not a wise strategy to go into NYC or SF with the intention to do short-term rentals because most STRs are not allowed without a hotel-like license.
In fact, most larger municipalities are riskier, from a short-term rental standpoint, because of the various stakeholders (hotels, lower income housing, housing stock) that have a more direct effect on politicians. We recommend going into a market that has established STR regulations, and even better, a market that has been holden to vacation rentals for a long time (think San Diego type cities).
If you fail to research the current and planned legislation in a market, than your planning to fail. Make sure you look at state-wide statutes as well as county, municipal and HOA plans for short term rentals. We do not recommend investing in units with HOAs, but if you do than it is worth looking at the make-up of an HOA board, or municipal council.
A big part of a municipality’s regulations is taxes. When you operate a short-term rental you are subject to a tourist/hotel tax. It is important that you know what and how much these taxes are. Not preparing to pay the extra taxes can destroy the profits of your short-term rental.
4. WHAT DRIVES TRAVELER DEMAND?
People travel to locations for a variety of reasons - family, vacation, business. It is important to understand why people are coming to your market, where they are coming from, and to define a market’s SEASONALITY. You do this to get an idea of your ideal traveler for your potential investment, and to pursue the homes that fit the mold.
Are most travelers coming into your area for business or pleasure? What types of amenities do these travelers want in a home? What places or landmarks do travelers want to be close to when coming to your market? If a downturn comes, are travelers still going to be visiting your market?
In a beach area such as Fort Lauderdale, a 2 bedroom on the water may be a better investment than a 3-bedroom off the water. While in areas that attract multi-generational families, a larger property is likely to achieve more occupancy than a smaller townhouse. In urban areas, a location with a parking spot can be in much higher demand by guests than one without because of the headache of finding and paying for parking.
Understand what drives travelers to your market and tailor your investment to these travelers.
5. WHAT IS THE SUPPLY, AND SUPPLY GROWTH, IN THE AREA?
Due to regulations, and the amount of housing supply, some markets are more prone to becoming oversupplied because of the low barriers to entry for short-term rentals. Now that COVID-19 has struck, it’s more important than ever to consider barriers to entry in the respective market because supply growth can quickly destroy your profits.
If you look at markets like Orlando, where they have little regulations, there are 55,000+ listings on Airbnb and HomeAway. Markets like Nashville, an increasingly popular travel destination for groups, only has 7,645 listings according to AirDNA.
At the end of the day, the basis of a short-term rental investment depends on supply and demand. If there is too much supply of hotels and short-term rentals, than it will be much harder to differentiate and generate profits.
Compare short-term rental markets based on their respective barriers, do your due diligence on what is driving their demand, and see where you can take advantage. This can be with scale, capital, or government relationships.
As seen above, you must take extra considerations into account if you plan to invest in a short-term rental investment, especially after COVID-19. While you may generate more revenue and profits than a long-term rental, it is subject to more risk. Do your research and know your potential downside so you invest in a short-term rental knowing both sides of the coin.