Buying a Home for Short-Term Rentals

Kitchen of an updated home that has been purchased to use for a short-term rental.

Airbnb had more nights booked in the U.S. in the last two weeks of May 2020 than during the same period the year before. And this was in the middle of a global Coronavirus pandemic, which gives a small glimpse into the meteoric rise of the short term rental market.

Airbnb, which is bigger than the five largest hotel chains combined, is just one of a handful of listing platforms used by millions every year. This frenzy has created a new industry where people from all walks of life can become real estate investors.

However, it can still be scary to buy a property for short term rentals if you've never done it before. Is it worth it to buy a property for short term rentals? How can you get started? Let's explore these questions and find out.

How Can You Determine If a Rental Property Makes Sense?

Before you get down to creating a listing for your short term rental property, you need to understand that you're embarking on a business venture. If you are looking for easy passive money, this might not be the right option.

Your first step before finding a property is to define your strategy. Are you looking to make the majority of your profit from rental income or an increase in the property value over time before flipping it? Are you catering to the business traveler, families on vacation, or young tourists?

All of these decisions have implications for the type and location of a home you'd like to acquire.

As you develop your business plan, you'll want to do competitive research to get a sense of the average price at which homes in your desired area are renting. The hospitality industry uses a metric called Revenue Per Available Room (RevPAR) to evaluate demand. RevPAR is calculated by multiplying the average rental price for a night by the occupancy rate. You can use this metric to compare potential properties across different geographies.

You'll use this information and a few assumptions to forecast the financial return of a potential project. This analysis and set of calculations are known as a proforma.

TV shows like HGTV's Fixer Upper love to focus on the home buying and remodeling process. However, your job here will be more similar to that of a hotel owner. When it comes to any investment, the money is made in the numbers! You'll need to have an excellent understanding of your monthly costs and expenses so that you can run a profitable operation.

What You Need to Know to Purchase an Investment Property

Buying a rental property differs from buying a home in which to live. Short term renters care about different things than permanent residents. For example, while you might care about having an awesome laundry room in your primary home, your rental guests might not even use it.

For many homebuyers, getting approved for financing is a major headache. But if you thought finding a mortgage was tricky, finding an investment property loan will prove even more taxing. Some lenders are starting to rule out buyers who intend to purchase a home for short term rentals, so you'll need to look for the right partner.

Once you find a suitable lender and you've homed in on a specific area where you'd like to purchase an investment property, you'll want to search for a home that will rent well. This often means finding the right location and finding a home that will accommodate several beds. Furnishing a couple of rooms with bunk beds is an easy way to increase the occupancy, and thus your rental income. While properties with higher bed-counts tend to do better financially, it's important to remember that property damage is positively correlated with the number of occupants, so there are pros and cons.

Finally, you'll want to understand the local and state regulations for short term rentals before purchasing. Some municipalities have stricter rules in place, and local short term rental and occupancy taxes vary widely, so it's important to know what you'll be dealing with.

The Cost of Owning and Renting an Investment Property

The true cost of owning a rental property is higher than some new investors realize because there are several expenses that they may not anticipate. These additional expenses include a business insurance policy that will cover your rental guests, cleaning fees or supplies, rental platform fees, welcome packs, and ongoing maintenance due to additional wear and tear.

One critical decision is whether you plan to manage your property yourself or hire a professional management company. If you are looking for a passive investment, hiring a manager will eat up a lot of your profits. On the other hand, managing the property yourself will take a lot of your time. I recommend managing the property yourself at first so that you can fully understand the business. Otherwise, how will you know if your property manager is doing a good job?

A typical short term rental management company charges a fee ranging from 18-20% of rental income. The lower end of the fee range would be 15%, while 25% would be on the higher end. For comparison, traditional property management companies for conventional long-term rental properties charge closer to 5-8%.

One expense that is unaccounted for is your time! If you are spending 4 hours a day cleaning, negotiating with prospective renters, coordinating calendars, and answering questions, you need to account for it as a line item in your proforma!

Best Cities for Airbnb Investment 2020

According to the vacation rental management company iGMs, the top 10 cities for short term rentals are:

  1. Milwaukee, WI
  2. Columbus, OH
  3. Indianapolis, IN
  4. Memphis, TN
  5. Philadelphia, PA
  6. Kissimmee, FL
  7. Phoenix, AZ
  8. Eugene, OR
  9. Dallas, TX
  10. Atlanta, GA

The list is based on each city's average cap rate, occupancy rate, average monthly rental income, and median property price. Once you find the right city for your investment, you'll want to run a similar analysis on a micro-scale to make sure that you feel confident with the purchase. While it may seem like real estate is a sure bet, no city is immune from foreclosures due to investments going sideways.

However, if done correctly, investment properties have proven to be very lucrative opportunities.

The views expressed by the author are not necessarily those of Fifth Third Bank, National Association, and are solely the opinions of the author. This article is for informational purposes only. It does not constitute the rendering of legal, accounting, or other professional services by Fifth Third Bank, National Association or any of their subsidiaries or affiliates, and are provided without any warranty whatsoever. Deposit and credit products provided by Fifth Third Bank, Member FDIC.