The popularity of AirBNB has many real-estate investors strongly considering vacation rentals for their property portfolio. Here, we will discuss the advantages and disadvantages of owning a vacation-rental property as an investment.
Although AirBNB has most recently captivated the media, websites like Homeway, VRBO, and FlipKey (TripAdvisor) have long offered vacation-rental owners with advertising and a steady source of clients. Unfortunately, the media attention has also attracted local governments to the party, which is leading to sometimes onerous regulations and higher taxes.
The developing market for private vacation rentals is, of course, a major threat to existing hotels. This “menace” could spur two different results: (1) lobbying of local governments to “crack down” on vacation rentals with regulations and taxes to raise entry barriers and business costs for their new competitors; and (2) hotels may try to join the game themselves with strategic purchases.
Some local governments are, indeed, beginning to interfere with vacation rentals and this pressure could arise in part from hotel lobbying. And, interestingly, Hyatt announced that it is investing in a home rental company that allows travelers to rent upscale private homes.
Consolidation of the vacation-rental market is continuing as longtime travel-booking site Expedia announced in early November 2015 that it is purchasing vacation-rental company Homeaway.
The vacation-rental market will likely develop and change over the next couple years as more-and-more people and companies (and governments) try to take a piece of this burgeoning market. Perhaps you should consider snapping up a piece for yourself?
The Advantages and Disadvantages of Investing in a Vacation-Rental Property
The decision whether to invest in a vacation-rental will depend on many specific factors that are individual to both your situation and the desired property. Real-estate is local, after all. But there are several considerations that you should understand when conducting your own analysis.
Why You Should Invest in a Vacation-Rental Property
Higher Rents than Typical Rental Properties
Investing in real estate—like anything else—requires a nuanced analysis that incorporates many factors. But, in the end, it really is a math problem with some open variables that you do your best to predict.
You must compare your costs with your expected income, then analyze potential risks and income growth, and determine whether the numbers “work.”
One of the major advantages of the vacation rental over the standard rental is that the expected income—when the property is rented—should be higher. That is, for the same property, you should receive a higher amount per period when the property is rented as a vacation rental compared to when it is rented as a standard long-term rental.
The reasons why the vacation rental rents are higher are (1) the property is furnished; (2) the term is shorter, so your customer—the tenant—is not receiving the volume discount (in time) of the standard rental; and (3) people splurge on vacations and your property income is more likely to follow the hotel and vacation pricing and growth than the long-term housing pricing and growth (which is stickier).
Of course, you have to do the math and come up with a realistic vacancy rate because it is likely that your vacation-property rental will be unrented more than your standard rental. Your vacancy rate will depend upon many factors, including the price you set, the location (do people travel there year round?), the management, the quality of the experience and the resulting reviews, and the marketing. Remember, this is a business and you should treat it as such.
The advantage of the vacancy days, however, are that you can use them for yourself or your friends and family. This transitions nicely to the next benefit.
You Have a Vacation Home
Pick a location you like because, guess what? You have a vacation property. You can either book it out yourself, or—depending upon your flexibility—you can wait until you have a vacancy and just show up.
If you book it ahead of time, you could lose some income, but planning is much easier. Of course, if you can make your vacation-rental-property use more spontaneous, you will optimize your income. Indeed, this may be one reason to find a vacation rental that is within driving distance.
Another option is that if you see you have a vacancy coming up, you can offer the opening to your friends and family (just make sure they clean up when they’re done). This is a great way to improve your popularity.
There may be tax implications if you use the property a certain number of days per year, so please consult your attorney or accountant. Those issues are beyond the scope of this article.
If you want to Sell, the Property is Staged to Sell
You should, of course, furnish your vacation rental—unless you are trying to market the “camping” experience and asking your tenants to bring some sleeping bags (which we don’t recommend). You should furnish it for function, but also aesthetics as pictures are almost everything—along with location and price—for prospective vacation-rental tenants.
Furnishing the home just right can take some work, but once it is done, the property is effectively “staged,” which means that if you want to put it on the market to sell, you will likely (1) obtain a higher price; and/or (2) sell it more quickly.
Future Retirement Home
If you choose wisely, you will pick a vacation property in a place you’d like to spend time. Perhaps with the kids in school and the busy job, now isn’t the time to move there, but nothing says you have to wait until retirement to buy a home in your dream city.
In fact, why not buy it now, let your tenants pay down the mortgage, and then move into it when you are ready? At that point, you will hopefully have some equity in the property and, depending upon your financing, your payments may be manageable. And who knows, maybe with the real estate already procured, you find a way to make your dream happen early?
Growing Investment Class
As vacation rentals become more popular for vacationers, they will also become more popular for owners, who will react to the increased demand. So if you can snag a property now that will make a spectacular vacation rental, you might find an additional source of potential buyers if you ever want to sell it.
You Can Choose Your Geographic Market
When you choose your primary residence, you have to consider such factors as your employment or business, schools (if you have or want kids), and proximity to family (as a positive or negative, depending upon your family).
A vacation rental allows you to dream a little more and just pick a place you’d like to go. There are, of course, important factors to consider, like any investment, but they are different factors than you’d consider for your primary residence and the more desirable destinations also make better vacation-rental locations.
When you consider location, you should think about not only where people vacation, but where they go for conferences. You may, for example, find a reliable flow of tenants if you choose a property near a city’s convention center. For example, San Diego is a great city for a vacation rental because many people travel to America’s Finest City for vacation as well as conferences. And the weather makes it a year-round destination.
Financial Benefits of Real-Estate Investing
As we discuss here, investing in real-estate can reap great financial rewards. Those benefits also apply to vacation rentals. But not only do you obtain the financial benefits of real-estate investing, you also own a property in a vacation destination that you and your fiends can use. And, eventually, maybe you move there yourself (after your tenants pay down your mortgage)?
If you want to learn about real-estate investing more generally, we highly recommend The Millionaire Real Estate Investor by Gary Keller, Jay Papasan, and Dave Jenks.
Concerns about Vacation-Rental Real-Estate Investments
Higher Costs in Management and Furnishings
With the higher vacation-property rents come higher costs. You must furnish your rental: This means furniture, as well as items like dishes, towels, etc.—anything your tenants will need. And that includes replenishing the towels and toilet paper between tenants. If your property is near the beach, don't forget to include some beach towels.
You could manage the property yourself if you are local, but I’d recommend a property manager, as you will have more tenant entrances and exits than a traditional rental property. Most vacation-rental property-management companies charge more than traditional property management because the role is more extensive. So you should incorporate that into your budgetary calculations.
Regulatory and Government Risks
Now that vacation rentals are becoming more popular, the government is stepping in with their traditional role of ruining the party. Expect that to continue. This, of course, adds some risk as your local government might add taxes, limit or regulate how you can rent your property, or forbid vacation rentals altogether.
Fortunately, in most cases, you should be able to sell the property if the regulatory controls became too draconian, as you could hopefully find a buyer that wants to either live in the property or rent it out to a long-term tenant.
If you are buying a property outside of the United States, thoroughly research that country’s laws and regulations and consider the risk—however remote—of nationalization of the property.
Your tenants may stay for a few days to a few weeks to a few months. Thus, you will have to find many of them each year and their tenancies may not go back-to-back. That means that you will likely have some openings that you can’t fill—vacancies. Make sure to incorporate these into your budget.
One way that you can reduce vacancies is to offer last-minute price reductions. You have to be a little careful as tenants—knowing this is what you do—may wait until the last minute to book your place. But not everyone can do that, so you should still find some tenants that book further ahead.
The Details Matter
A vacation rental offer both profit and pleasure, but you must do your homework and consider the numbers and details—just like any other investment. Location matters just as much for vacation rentals, possibly more, as it does for any other real-estate investment.
Take your time finding the right property; you often make your money when you buy because that is your opportunity to find a great property at a great price.
In addition, consider that a vacation-rental property is a business like any other real-estate business. If you decide to utilize a property manager, that person will be extremely significant in how your business performs. That is the person that will interact with your tenants and will make sure that everything runs smoothly. If you do well, many of these tenants could come back year-after-year, so treat them well and make sure anyone you employ does the same.
If you aren’t happy with your property manager, find a new one. This is an important position, so don’t take it lightly.
Finally, have fun. Owning and running a vacation-rental property is a business, but it should be a fun business. Take advantage of the ability to use and share your property and enjoy the process of looking for just the right one. This is a great opportunity to travel all over the world researching.
If you have experience with vacation rentals, please share any tips or insights you have in the comments below.