Over the past few years, vacation rentals have grown in popularity. A vacation rental is usually a whole house or apartment that the owner rents out to tourists visiting the area. Unlike a hotel, there are no communal areas shared with other guests. This was particularly attractive during and immediately after the COVID-19 pandemic when people were trying to travel and enjoy vacations while still limiting contact with strangers.
Depending on the rental property, each member of a party may be able to have their own room. Vacationers can save money by bringing groceries and cooking in the kitchen instead of eating out. Guests can take advantage of a private pool, and parents traveling with young children don’t have to worry about naps being disturbed by noise carrying through the thin walls of a hotel room.
While some travelers will always prefer hotels and resorts, vacation rentals offer flexibility and benefits that give them a competitive edge. Should short-term real estate investors consider adding them to their portfolio?
What are the benefits of investing in vacation rentals?
There are several ways that vacation rentals can enrich your portfolio, income, and even your personal life.
Depending on where your rental property is located, demand may be higher during certain times of the year. Even different weekends within the same month can see wildly different levels of interest. For example, a beach property on the Jersey Shore may witness high demand during Labor Day weekend and almost no interest by the end of September.
With a long-term rental, you are locked into a certain rate for six months to a year or more, but you can adjust the price of a short-term rental on a day-by-day basis. For holiday weekends, you can charge significantly more than you would during the very beginning or very end of the season based on what people are willing to pay. This allows you to keep pricing competitive to ensure continuous occupancy and maximize your income.
Higher earning potential
Overall, short-term rentals have a higher earning potential than long-term rentals. This is partially due to the owner’s ability to adjust pricing dynamically throughout the year based on demand. As previously mentioned, you can raise prices when demand is high and lower them during seasons when demand declines. You can also increase the overall value of your property over time through continuous renovations.
People who are looking for a vacation rental are looking for a certain set of amenities that hotels don’t offer, and they are willing to pay a premium to get them. If you have a well-furnished vacation rental with a pool, entertainment center, or other amenities, you can charge a higher rate and still attract customers. There are also additional ways to add value, such as a coin-operated laundry machine or arranging transportation services for an additional fee.
Vacation rentals may also be considered a relatively safe investment. Even during economic downswings, people still want to go on vacation. Your ability to adjust prices based on demand makes it more likely that you will continue renting and making a profit even during a recession.
If you own a property that generates income instead of serving as a personal residence, you may be entitled to write certain expenses off your income taxes. This includes taxes and mortgage interest, repairs, maintenance, renovations to improve the property, insurance premiums, legal fees, and any depreciation of the property over time.
In order to qualify for these tax write-offs, your vacation rental property must meet two requirements: first, it must be available to rent more than 14 days out of the year. Second, you or your family may not use it for more than 14 days or 10% of the total number of days it is rented out. Since there are usually 365 days in a year, this means you could use the property for a maximum of 33 days each year if you are able to rent it out for at least 330 days.
What if you want to rent the property out for part of the year but use it for longer than 10% of the time? In this case, it would be considered a mixed-use property. Fortunately, mixed-use properties are also eligible for some write-offs. Calculate the total days the property was used by you or someone else and the total percentage of that time the property was rented. Say you use your property for 90 days and rent it for 15. Since the property was rented for 16.7% of the time it was used, you would write off 16.7% of the property’s expenses on your taxes.
Personal vacation accommodation
As outlined above, you are able to stay in your vacation rental property within limits. This means that for up to one month each year, as the owner of a vacation rental property, you will be able to take a vacation without paying for accommodations. Your vacation rental property can be used to host celebrations for special events, celebrate the holidays, or just get away from the weekend. While this might not be the primary benefit of investing in a vacation rental (again, the number of days you could actually use the property for personal use is limited), it’s certainly an added bonus.
Are there drawbacks to investing in vacation rentals?
While there are many advantages to investing in vacation rental properties, there are also additional steps and considerations potential investors should keep in mind.
Owning any kind of rental property will include some property management. However, with short-term rentals, services are expected to be performed more frequently. Hotels and resorts have set the standard for what people expect from vacation accommodation; if your guests don’t enter a thoroughly cleaned and tidied space, they are likely to view your rental as sub-par.
This means arranging for the property to be cleaned between each guest, even if you have a succession of guests staying for only one night at a time. During cleaning, you will also need to inspect the property for any damages or missing items and address any issues immediately.
Owners of long-term rentals can usually pass some expenses—such as internet and other utilities—over to their renters. Short-term rental owners, however, are responsible for covering all the monthly expenses associated with the property, including mortgage payments, pool cleaning, landscaping, property management services, and someone to come in and clean the property between each guest. Usually, if renters want a cleaning service, they have to pay for it themselves. However, when you are providing vacation accommodations for travelers, a certain level of cleanliness is expected.
Seasonal fluctuations in demand
Depending on where your rental is located, demand is likely to fluctuate throughout the year. If your property is located in a coastal area, you aren’t likely to see much demand from October to April unless your property is located someplace like Florida. Even if you are located in a location that guests can enjoy year-round, like the mountains, your pool of potential renters will be smaller during the part of the year when kids are in school, and families are less likely to travel. It may be hard to generate a consistent monthly income throughout the year with this type of investment.
Market outlook for vacation rentals
The good news for potential investors is that the short-term vacation rental market is expected to continue growing over the next decade. According to Grand View Research, the market was valued at an estimated 109.76 billion USD in 2022 and is expected to continue growing at a compounded annual growth rate of 11.2% through the year 2030, reaching a value of 256.3 billion USD. Homes will generate the most revenue, followed by resort condominiums and then apartments.
Some of the factors driving the popularity of vacation rental properties include the rise of remote work and eco-conscious travelers. Now that many people can work from wherever they want, it is easier for people to take “vacations” without taking vacation days. Renting a house or apartment somewhere nice is more comfortable (and potentially affordable) than renting a hotel room to work out of. Large resorts consume a lot of resources, while a single-family home or apartment in a nice area may be seen as more sustainable.
Investing in Vacation Rentals with Arabella Real Estate Fund
Short-term vacation rentals are one of the many real estate investments included in the Arabella Real Estate Fund’s assets, which also include build-to-rent communities, independent living communities, and self-storage facilities. Arabella Capital takes an innovative approach to real estate investment designed to help our investors maximize their returns.
We invest in a diverse array of properties and property types to create a balanced portfolio that is resilient to fluctuating market conditions. Our fund specifically targets properties in high-growth markets throughout the Southeastern United States that offer enhanced returns. We also thoroughly evaluate and vet any project before adding it to our portfolio to ensure the potential risks and returns are in the best interest of our investors.
Frequently asked questions about investing in vacation rentals
Can I finance a vacation rental?
Yes, there are multiple options for financing a property that you intend to use as a vacation rental. The first is a traditional mortgage, like you might take out on a property that you use as a primary residence. To qualify for a mortgage, you will need to provide usually around 20% of the property’s purchase price and demonstrate a good credit history. A traditional mortgage can offer you lower interest rates and are ideal for long-term investments.
Other options include asset-based loans and hard money loans, both of which offer higher interest rates, higher initial down payments, and shorter repayment terms. However, they may have a lower barrier of eligibility. An asset-based loan is underwritten based on the potential income of the property. If you default on the loan, the lender takes control of the property. Hard money loans have no requirements for personal or property-level income but may require a much larger down payment.
Other options include cash-out refinancing, 401K loans, or borrowing from a private lender.
Are there tax benefits to investing in a vacation rental?
Depending on how much time your property is rented out during the year, you may be able to write off some or all the associated taxes on your income tax return. The IRS understands that to generate income from a rental property, you will need to spend money on some necessary expenses. They do not count the money needed to maintain your business as taxable income. For a short-term vacation rental, this includes things like a cleaning service, mortgage interest payments, utility bills, and the cost of conducting repairs, maintenance, and even renovation.
How do I identify a good vacation rental investment?
It’s a cliché, but it’s true: location, location, location. Where are you looking to purchase your rental property? How high is the demand for rental properties in that area? How much does that demand fluctuate seasonally? Consider the monthly expenses you will need to keep your property fit for guests. Will the revenue cover them? When you invest in a real estate fund through Arabella Capital, we do this work for you.
What are some of the expenses associated with vacation rentals?
Each month, you may pay interest on any loans you used to purchase the property, a cleaning service to tidy up between reservations and prepare the room for the next guests, a property manager to inspect for damage or theft, the utility bill, any taxes or fees your local government charges to run a rental property, and more. You may also need to pay for a pool service if your property includes this amenity, yearly maintenance on your HVAC and other appliances, and any emergency repairs that come up.