Your Guide to Short-Term Rentals
Platforms like Airbnb and VRBO have gained immense popularity. Here is a guide to short-term rentals and how one can get involved. The post Your Guide to Short-Term Rentals appeared first on The White Coat Investor - Investing & Personal Finance for Doctors.
By Dr. Jim Dahle, WCI Founder
I consider a small short-term rental empire to be the fastest route out of medicine. Due to the increased profit available in this hotel alternative, the investment returns can be such that one can exit medicine within just a few years, assuming your student loans have been paid off. Five years is an aggressive but not an unreasonable target. How can that be? Let's talk about it and some of the other important considerations about short-term rentals.
What Is a Short-Term Rental?
A short-term rental is renting out a house, condo, or townhome for periods generally less than one month and averaging about seven days. These properties are often advertised on Airbnb, VRBO, or on their own websites. Long-term rental landlords are offering housing. Short-term rental hosts are running a hotel business.
Why Is There So Much Money in Short-Term Rentals?
All the same characteristics of real estate exist just as much in short-term rentals as in long-term rentals. There's insurance and property taxes and mortgages and depreciation and vacancies and repairs. The difference is on the revenue side. The revenue stream is more uncertain, and the property will often be unrented for many nights during a given month. However, the amount of money you get from each night it is rented is dramatically higher with a short-term rental.
Guests (rather than tenants) are comparing the price to a hotel room rather than a rental house. A rental house might rent long-term for $2,000 a month. But a hotel room might rent for $200 a night. If your two-bedroom short-term rental is priced at $300 a night, prospective guests will think “For only 50% more, I get TWO rooms plus a kitchen, living room, and garage.” They don't think, “Wait, these guys are charging me 4 ½ times as much as they could charge a long-term renter.”
Thus, the revenue from a short-term rental—even one only rented for half the month—is at least twice as high as from the same place rented long-term.
More information here:
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The Expenses Are Higher, Too
Before you get all googly-eyed looking at all that extra revenue, consider that the expenses are higher, too. You've now got people “moving” in and out two or three times a week, generating some additional wear. Since you are constantly looking for new guests, the costs of marketing are much higher. Airbnb and VRBO charge fees. The place needs to be cleaned in between each set of guests, too. That cleaning fee you can charge isn't pure profit (at least not all of it). If you don't want to manage it yourself, you will find that the cost is dramatically higher than the 5%-10% you might pay for a long-term rental. It can be as high as 30% or even 35%.
And vacancies aren't rare; they are the norm. Price your rental wrong or advertise it poorly, and it might sit empty for three out of four weeks. In some areas, like beach towns or ski towns, there is a seasonality to short-term rentals, and you might have twice as many vacancies even though you're charging half as much in the off-season. But most of your expenses will be exactly the same.
The biggest expense probably comes from the fact that long-term rentals are generally unfurnished and short-term rentals are completely and meticulously furnished. You'll need art, furniture, electronics, and maybe even some treats. You'll be paying for the Wi-Fi (it better be fast) and the other utilities. There are also often some “extras” to help distinguish your property from others. These might be snowshoes, snorkels, or surfboards—all of which have a tendency to be damaged or disappear and need replacement. You will need enough money to put down a decent down payment to ensure cash flow positivity, and you'll need additional capital to furnish the place. If you go to sell it or convert it to a long-term rental, you'll take a huge loss trying to sell all those furnishings.
Risks Are High
You face a lot of competition for overnight lodging. Not only are there more and more people trying to do short-term rentals all the time, but many of them are only on the market for the “good months” of the year. Plus, there is the constant threat from hotels and motels. The hospitality game is their bread and butter, and they can put up serious competition. The competition can be cutthroat.
A bigger worry is legislative risk. Many local areas view short-term rentals as contributing to their housing shortage, and they are passing ever stricter rules governing their use. Whether it's the city council, the state legislature, the local HOA, or just the neighbors, there will be people who don't like how you're earning your profit.
And then things happen. Like pandemics, where people just stop traveling altogether. Perhaps the best backstop to a short-term rental is if it can still be viable as a long-term rental. If the price you're paying for the property means it is only viable as a rarely vacant short-term rental, there's a good chance it won't work out for you.
The Short-Term Rental Loophole
One great aspect of short-term rentals is that one can qualify to use the depreciation (including bonus depreciation) to offset active income far more easily than with long-term rentals. With long-term rentals, you have to reach Real Estate Professional Status, requiring a minimum of 750 hours in a year. With short-term rentals, that minimum is only 100 hours, which is actually pretty easy to reach if you're managing the property or properties yourself.
Thus, it can be a great part-time gig for the non-physician member of a couple, and the depreciation can offset some or all of the earned income from the physician. This additional tax benefit adds to the overall return of the venture.
More information here:
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Can This Really Get Me Out of Medicine?
At the beginning of this post, I said that short-term rentals are the fastest reliable way out of medicine. Here's how that works. First, you'll need to manage the properties yourself, at least for a while. You simply can't give up 30% of the revenue to a property manager and expect this to be as awesome as it can be. With efficiencies and systems, you can minimize the work involved. You might even do the cleaning and handy work yourself in the beginning, just to see what's really involved.
Done properly, it is entirely possible to have a cash-on-cash return of 20% on a short-term rental portfolio. If you have $500,000, you can use leverage to buy four separate $500,000 properties with a 20% down payment each (with the other $100,000 going toward furnishings). You manage it yourself, and you can expect cash flow of perhaps $100,000 a year that can pay for your living expenses. Most physician families can come up with $500,000 of capital within five years of paying off their physician loans. Many can do it even faster.
That 20% yield isn't the only source of profit either. The mortgages are being paid down. The properties are appreciating. Perhaps the depreciation is reducing your earned income tax bill. Even if you want more than $100,000 in income to live on, it won't take that much longer to have eight, 12, or 20 of these. At a certain point, your profit will have to drop as you hire out management, but that has its advantages too since it gives you the freedom from a job that you were looking for in the first place.
The path isn't as easy as it was a few years ago when nobody was doing short-term rentals. There is now a lot more competition and certainly more regulation than there used to be. But carefully chosen properties can still provide fantastic returns, albeit with more risk and certainly more work than a portfolio of index funds or even other forms of private real estate.
Do you feel ready to learn more about real estate? WCI's No Hype Real Estate Investing course includes an entire section on short-term rentals. Taught by Dr. Jim Dahle and more than a dozen other experts, this course is packed with more than 27 hours of content, and it gives potential investors the foundation they need to learn about all the different methods of real estate investing. If you’re interested in real estate investing, you can’t afford to miss the No Hype Real Estate Investing course.
If you're not interested in short-term rentals and are looking for a more passive private real estate experience, check out our partners below:
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Have you ever considered a short-term rental property? If so, did you decide against it, or did you go for it? What else should we know about short-term rentals?
The post Your Guide to Short-Term Rentals appeared first on The White Coat Investor - Investing & Personal Finance for Doctors.
