With the rise of the sharing economy, platforms like Airbnb, VRBO, and TurnKey are redefining short term rentals and what they mean for homeowners. Here’s why a short term rental could work well for you—and why it might not.
Are short term rentals a good investment?
It’s easy to see the appeal. Short term rentals usually fetch higher prices than a long term lease. You don’t even have to own multiple properties to participate—many hosts rent out a spare bedroom in their primary home. Alternatively, some will rent out their entire primary residence when they go on vacation, or they might choose to crash at a friend’s place for a few nights while their guests are in town. Most homeowners participating on these platforms appreciate the flexibility of setting their own rental schedule, without being trapped in a year-long lease.
The real question, however, is whether or not short term rentals are going to provide a greater return on investment over long term rentals. The higher booking prices aren’t the only story. There’s the turnover rate, off-season vacancies, expenses, taxes, and the demands of being a host.
Before answering the question, there are a lot of factors to consider.
Is it legal?
Before considering short term rentals, you should take a look at your city ordinances and determine whether or not short term rentals are permitted. Some cities, such as New York, San Francisco, Los Angeles, and Santa Monica have cracked down on Airbnb, claiming the increased presence of short term rentals contributes to the housing crisis.
For example, in New York City, the Multiple Dwelling Law does not allow short term rentals for fewer than 30 days in buildings with three apartments or more. The exception would be if it’s the owner’s primary residence.
San Francisco allows up to 90 days of short term rentals per year, but owners must register with the city and pay a 14% hotel tax. In Los Angeles, short term rentals are not permitted for fewer than 30 days in single family home residential areas.
Even if your city doesn’t have similar restrictions yet, property owners should be prepared for that possibility, particularly if you live in a major city. Make sure your profit margin would be wide enough that if taxes increased or regulations sprung up, you wouldn’t be underwater.
Alternatively, Airbnb may be permitted in your city, but not allowed by your HOA. Be sure to check your Covenants, Conditions, and Restrictions (CC&Rs) for the policies about short term rentals.
Is the area in demand?
Long term rentals are profitable because no matter where they are, people need a place to live. Short term rentals depend on other factors. Do you live in a popular destination? Major cities usually receive more traffic (and can set higher rates) than smaller towns. Does your area host seasonal events that cause an influx of tourists looking for short term accommodations? Are there attractions in your area such as restaurants, museums, nature preserves, or a thriving downtown?
Before jumping in because you think your property would make a perfect short term rental, consider the area and the demand. Look on Airbnb or VRBO to find rentals in your area and see what they’re charging. See if the numbers make sense based on what you know of the area’s popularity and the amount of tourists looking for a place to stay.
Taxes, insurance, and interest rates
Operating a short term rental may affect your insurance and interest rates. Although Airbnb offers its own insurance, it’s a good idea not to have that be your sole safety net in case one of your guests causes significant damage to your property. Talk with your homeowners insurance provider and let them know what you want to do. Don’t be surprised, however, if you see your premiums go up. Operating a short term rental business on your property may require you to take out additional coverage.
Short term rentals can also affect your interest rates for future loan applications. For owners who are looking to refinance, many want to tap into their home equity for renovations, school tuition, or paying off medical debt. However, not all lenders allow Airbnb income to count in their application. Since mortgage companies look at your debt to income ratio, not being able to count a significant portion of your income could lead to more limited options and higher interest rates when looking to refinance your home.
There are some solutions to this problem. Fannie Mae launched a pilot program last year in partnership with Citizens Bank, Quicken Loans, and Better Mortgage that will allow Airbnb hosts to count their short term rental income on their application. One stipulation is that owners must be renting out their primary residence and not a vacation home. This program will give Airbnb hosts more refinancing options and better interest rates.
If you’re renting out your primary residence for 14 days or fewer, you do not need to report what you earn as rental income. For the IRS, it’s as if your (very) short term rental never existed. If you rent for a period longer than 14 days, you must report your income to the IRS.
Renting out a place that is not your primary residence (regardless of the amount of time) must be reported. However, you have more options for tax deductions on a rental property that is not your primary residence, provided you keep careful track of your expenses.
Putting your property on the market as a short term rental mean you may have to pay sales tax and occupancy tax to the city. This can be as high as 14%, taking out a large chunk of your profits.
Part of the short term rental game is dealing with turnover. It’s rare to have people stay for weeks on end. Even if you manage your bookings so that you have back-to-back guests, it takes a high level of coordination to clean and prepare the unit for the next party.
In between guests, hosts must ensure the following:
- The unit is thoroughly cleaned
- Sheets, towels, and other linens are replaced with fresh ones
- All consumables are refilled (toilet paper, soap, coffee, tea, etc.)
- Inventory is conducted to ensure everything is still there
In addition to preparing the unit for new guests, it’s important for hosts to have an established check in process. Whether that means meeting people in person or installing smart locks on your front door, owners need to be creative in how they automate arrivals and departures.
For some owners, this means hiring a property manager. To have someone dealing with the day to day makes a huge difference in saving you time, but it will also cut into your bottom line. While most long term rental property managers charge an 8-12% fee, it’s not uncommon for that percentage to increase to 25-40% in short term rentals.
If you’re considering managing your short term rentals yourself, you should ask yourself a few questions and make sure this is an area where you would thrive. For instance, how hands-on of a landlord do you like to be? Do you jump at the chance to handle maintenance requests or other issues? Or do you prefer your investment to be more passive? Do you generally enjoy property management? What about dealing with tenants?
Airbnb guests expect more of a hotel experience, while long term tenants are looking for a home where they can live and keep their possessions. Short term rental management isn’t your average real estate investment. It’s not passive, and it’s not even that similar to being a landlord. It’s much more like working in the hospitality industry.
This means there is a greater emphasis on the relationship with the client. They are your renters, your guests, and also your reviewers. For Airbnb and other rental platforms, reviews can make or break a rental property. If you’re serious about starting a short term rental, make sure you’re willing to put in the extra effort it takes to make your guests feel at home. The positive reviews they leave will drive future traffic to your listing.
When you’re a landlord of a long-term tenant, the responsibility is usually on them to pay for some or all utilities. For short term rentals, that responsibility falls on the owner. This means electricity, heating, cooling, and of course, Internet. These monthly payments can add significantly to your expenses, especially if you have inconsiderate guests who leave the lights on or crank the AC.
Be aware of your state rental laws. In some states such as California, living in a property for 30 days or more establishes a month-to-month tenancy. If someone rents out your property for a month and then refuses to leave, you will have to start eviction proceedings just as if you had a long-term tenant.
Unlike long term rentals, short term rentals need to be furnished. This includes living room furniture, beds, sheets, shower curtains, towels, plates, cups, bowels, mugs, flatware, paper towels, cooking pots, pans, and utensils, plus anything else you would consider necessary for setting up a home.
Although it may seem like a steep cost up front, your goal is to provide your guests with a home away from home. This means anticipating their needs and making sure their stay is as comfortable as possible.
But is it more profitable?
With all these things taken into consideration, are short term rentals more profitable than long term rentals? The answer is it depends...on your area, on how many nights you rent each month, on your expenses, and many other individual factors.
Hopefully by now you understand the types of questions you should be asking. Research your city’s policies, tourist trends, taxes, and fees related to a short term rental. Ask yourself if you want to rent out a room, rent out the entire property, or come up with some other arrangement. Figure out how much time you want to dedicate to this each month, and what sort of monthly expenses you will incur. Establish an efficient check-in and turnover process so that you don’t have to waste time with each booking.
If you’re interested in reading a case study, one blogger undertook a year long experiment to see if listing her property as a short term rental would be more profitable than listing it for long term. She documents the highs, the lows, and gives good insight to someone considering short term rentals.
Short term rentals can be profitable for landlords, but no one should jump in blindly. Consider the fact that it’s a different industry from traditional landlording (hospitality versus real estate) and that there are different taxes and fees.
Also consider your personality. Some owners are hands on and love interacting with their tenants. Others prefer to be hands off while keeping a more passive investment. Just because you fit into one camp or the other doesn’t automatically exclude you from short term rentals. It’s just a matter of whether or not it will be profitable for you, and whether or not you will enjoy it as a business.