How to Invest in Short-Term Rentals

Rebecca Lake

Real estate can be a foil to stock volatility, not to mention an effective way to generate income. Owning a short-term rental could be a money-maker for investors who want to diversify their portfolios.

"The prospects for short-term rentals are great," says Jeff Checko, a real estate broker with The Ashton Real Estate Group of RE/MAX Advantage in Nashville. "It's going to continue to be a popular option and if property owners are able to continue operating under the same guidelines that we see right now, short-term rentals will thrive."

Companies such as Airbnb and VRBO have brought the short-term rental market into the mainstream, making it easier than ever for investors to profit from real estate ownership. Rather than getting tied into long-term leases, property owners can capitalize on local demand for temporary and vacation rental housing.

"The main advantage of investing in a short-term rental property, especially if it's furnished, is that an owner can charge more per month than a typical, long-term unfurnished rental," says Mihal Gartenberg, an agent at Warburg Realty in New York.

[See: 5 Ways to Invest in Real Estate Without Much Money.]

Owning this type of rental property allows investors to reap income over time while the underlying asset appreciates. As with any other type of investment, there are some ground rules to know before diving into short-term rental property ownership.

-- Learn the legalities.

-- Set realistic expectations.

-- Research the market carefully.

Learn the Legalities

Owning real estate for rental purposes means toeing the line legally. For example, that includes observing landlord-tenant laws set by the state. With shorter-term rental agreements, it's important to understand how local regulations can shape the market.

"Short-term rentals can be a robust business model; the most concerning exception is local laws," says Diana Hill, director of real estate education at OTA Real Estate. "Many municipalities have put a stranglehold on short-term rentals."

Cities and towns may dictate that rentals must be limited to weekdays only or that rental agreements can't be any shorter than one month.

In some cities, purchasing a property for the sole purpose of renting it out on a short-term basis is illegal, says Daniela Andreevska, marketing director at real estate analytics firm Mashvisor.

New York, for instance, has exceptionally strict short-term rental laws that prohibit apartment rentals lasting less than 30 days. Airbnb hosts are allowed to rent space temporary but only in homes that are also their primary residence.

Additionally, many major cities such as San Francisco and Los Angeles, require property owners to obtain a business license and/or register as a business entity to rent on a short-term basis.

Understanding local rental ordinance rules is a must but investors should also keep in mind that rules can change.

"It's important to recognize that we're experiencing a dramatic tug of war when it comes to regulating these types of properties," Checko says. "Elected officials have to try to please the people who believe in property rights and those who are trying to restrict the number of units eligible for short-term rentals."

He says, it's important to monitor when mapping out rental investment plans.

Set Realistic Expectations

After covering the finer points of legally renting property on a short-term basis, the next step is considering the potential return on investment.

Checko says the main advantage associated with these types of properties is that rental income may exceed that of a typical long-term rental on a yearly basis. For example, renting out a beachfront home at $2,000 per week for 12 weeks during the summer could yield more gross rental income than a mainland home that rents for a year for $1,000 or even $1,500 per month.

[See: 7 of the Best Ways to Invest in Real Estate.]

Investors also have flexibility in deciding when to rent or when not to, based on seasonality, to cash in on the highest rental rates. With a long-term rental, the rental rate is locked in for the entire lease term. That means property owners may have to wait a year or more before the lease expires to increase the rental rate.

Those are upsides of investing in properties for vacation rentals or home-sharing but consider what needs to be invested first, as well as on an ongoing basis.

"Newbies in the short-term rental world should consider all the expenses they'll incur and ensure that the rental income coming in will more than cover their expenses," Gartenberg says. That includes costs for maintenance, repairs and upkeep as well as property taxes, homeowner's insurance and mortgage payments for a property that's financed.

Investors also need to factor in the time commitment that's involved.

"To me, short-term rentals are more of a business than merely a real estate investment," Hill says. "The owner is managing a lot more than just the real estate. They have to maintain the aesthetics, check-in/out process, cleaning, marketing, being a host, guest satisfaction and the accounting."

Checko says investors shouldn't think of vacation or temporary rentals as a "set it and forget it" arrangement. While the income generated may be largely passive, property owners still have to be hands-on in protecting their investment.

Research the Market Carefully

In real estate, it's all about location, location, location. That's particularly true when it comes to owning properties to rent on a short-term basis.

"The important thing you need to do is choose the best market for investing in a short-term rental property," Andreevska says. "While major cities attract a lot of tourists and business travelers, you should not ignore smaller towns."

The key to choosing a location is finding the best combination of demand for short-term housing and profitability.

[See: 8 Real Estate Investing Mistakes to Avoid.]

Andreevska says using similar rental comparisons can help with estimating how much to charge for a nightly rate and the overall return on investment that can be expected, based on operating expenses and occupancy rates.

In addition to having the right location, the property itself needs to appeal to short-term rental seekers. That may mean investing some time and money in refurbishing or renovating a property to add curb appeal if the property in question isn't turnkey. Those costs, along with the costs of financing a rental property or purchasing one with cash, would also need to be factored into initial investment calculations when gauging profitability.

Bottom line? Do your homework, Hill says.

"Find out what the draw is of the area. If it's seasonal, run the numbers and not just the best-case scenario," she says. "Be prepared for it to take six months until you're up to full capacity and stay aware of local laws that could put you out of business."