This blog post has been updated May 2024 for freshness and accuracy
There’s a lot of appeal to investing in a vacation rental property. Not only does it provide a great spot for you and your family to travel, but it’s also an opportunity to diversify your investment portfolio and build wealth over time. Perhaps you’re looking into purchasing your first rental, or maybe you’re toying with the idea of investing in even more locations. Regardless, before diving into this quickly growing market you’ll benefit from exploring some of the nuances, considerations, and strategies.
The vacation rental property market is directly tied to the overall economy. When people are traveling, cash flow will be high, but when the economy takes a hit, tourism will be one of the first things to fall. As such, you need to take stock of the overall tourism market, both in general and in your local market, to decide what kind of investment makes the most sense for you at this time.
62% of Americans stated that they intended to travel more in 2023, and the numbers support this. The travel industry grew by 4.4% last year, with California alone experiencing an 8% increase in tourists. The market has reached about 80% of its pre-pandemic levels, and it’s expected to rebound further in 2024.
It’s clear that this is a good time to invest in vacation homes overall, but you also need to choose your timing carefully. When do you believe you can have the property ready? Will it be available for seasonal demand in your area? Answering these questions means understanding the typical peak seasons in the area of interest and planning accordingly so that you’re ready for the season.
Lastly, you must also consider general market conditions, such as current interest rates, so that you can get the best possible terms for your vacation rental loan.
Are You Ready to Invest in Short-Term Rentals?
The short-term rental industry is clearly booming, yet before diving in it is important to evaluate this strategy from different angles. Consider consulting your financial and other advisors for personalized advice.
Making Sure You are Financially Ready
Many new real estate investors do not realize that a larger down payment is needed for investment properties than for owner-occupied homes. With consumer mortgages, you often can put down as little as 3%, yet with investment properties, you will likely need at least 20% of the purchase price.
You also are going to need to make sure you have enough money to fully stock your vacation rental property with furniture and amenities, in addition to any closing costs, insurance, vacancy expenses, and, of course, your down payment.
Pros & Cons of Vacation Rentals as an Investment Strategy
Pros
Here are the main pros of investing in STRs:
Highly Lucrative: You may be able to generate higher returns with vacation rentals than with long-term rentals. Typically, you will generate more rental revenue with a well-performing short-term rental. These higher revenues usually are partially offset by higher operating expenses.
High Demand and Marketing Potential: With the amount of vacation rental listing sites available, not only is it easy to market your property to potential vacationers, but there is also a growing amount of demand for vacation rentals.
High Appreciation Potential: Higher-priced properties in desirable locations tend to appreciate more than your run-of-the-mill long-term rental property.
Personal Use: Owners can use the property for a limited number of days each year without losing their tax benefits.
Cons
At the same time, there are some downsides to this investment strategy:
Regulations: Many cities and homeowner associations have regulations and even bans on short-term rentals. That’s why it is extremely important to check the requirements in your area before purchasing a vacation rental. Some cities, however, such as beach towns, are very supportive of short-term rentals. It’s always a good idea to confirm.
Off-Season: Vacation rentals tend to be seasonal. For example, summer is a great time to go to the beach, but November is not as big of a draw. Lodgify has great tips to increase off-season bookings.
Management: When you have guests checking in and out every three days, your short-term rentals need cleaning every three days. You also must get new guests their keys and collect keys from departing guests. It can be a lot of work and particularly challenging if you live in another city. That’s why a good property management platform or company can be a game-changer.
Volatility: Consumer spending on travel and leisure is subject to changing economic conditions. Often during recessions, consumers spend less on travel and leisure. Plan accordingly to be able to handle an increase in vacancy in the event of an economic slowdown.
If you have fully evaluated the STR investment strategy and would like to move forward, here is our guide to finding, financing, and maintaining vacation rentals backed by our decades of experience and industry expertise.
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What Makes Financing Vacation Rentals Different
Investors typically turn to alternative lenders like Visio Lending for a few reasons. The first situation is if they are self-employed, including owning their own business. Another reason would be that they already own too many properties to qualify for another conventional mortgage.
Finally, and importantly, they may turn to an alternative lender because they want to own their investment properties in a legal entity to protect their other assets. That is not allowed with conventional mortgages. We’ll cover some of the key nuances of financing an STR below.
Residential Properties Need Residential Appraisals
Traditionally, for rental properties, appraisers fill out a 1007 report on comparable rents for long-term leases– think a year or more. Appraisers primarily appraise homes for owner-occupiers. Every once in a while they are asked to appraise a home as a long-term rental.
So, in most markets, they rarely are hired to appraise an STR or vacation rental. Getting an accurate appraisal of an STR or vacation rental’s potential gross rents, therefore, can be difficult because most appraisers are unsure how to determine short-term rents.
As an alternative lender, Visio is able to use a common-sense approach to determining STR rents. Visio considers any actual rent performance available on the property and then augments that information with comparable data from a variety of data sources. Unlike a licensed appraiser, Visio is not limited in the information it can use to establish an appropriate rent estimate.
Turnover Costs
Let’s say you generate $3,000 per month on an STR and only $2,000 a month on a long-term lease for the same property. While it might look like the STR is far more lucrative, in reality, the turnover and maintenance costs associated with an STR are higher so you need to make some adjustments before drawing a conclusion.
At Visio, we adjust our models for STRs by adjusting the gross rents used in our underwriting calculations to normalize them against long-term rentals. Our goal is to do as much as we can to STRs to make comparing them to long-term rentals apples to apples, instead of apples and oranges.
Regulatory Risks
Owning a vacation rental in Orlando by Disney World is a different ballgame than owning one in the heart of an elite neighborhood in Boston.
While a large part of Orlando’s economy relies on tourists, in a more suburban neighborhood, the city might not be as open to short-term renters and might pass regulations restricting them. This can be tricky for a lender, particularly in cases where the owner designed or modified the house to accommodate guests.
A nine-bed, nine-bath house might be fantastic for vacationers, but not for many long-term renters. So, what happens if the short-term use becomes outlawed? This is an issue any lender needs to consider when underwriting a loan.
Visio Lending’s Leading Vacation Rental Loan Program
Recognizing the nuances associated with financing short-term rentals, Visio Lending spearheaded a program that is underwritten based on vacation rental income rather than an investor’s income and assets. Here is why our vacation rental product is the best on the market:
- We offer common sense underwriting of your short-term rentals.
- Our loans are full, 30-year terms with no balloons.
- We are a low documentation lender and do not require tax returns or personal income statements.
- We lend to corporate entities, so investors can protect their identity and assets.
- Our pricing is simple and haggle-free.
