Is Now a Good Time to Buy a Short Term Rental?
Updated: Aug 26, 2022
Yes - as long as you do your homework! There is still plenty of opportunity to own a profitable short term rental in today’s marketplace. Even as the market changes, short term rentals often provide a much higher ROI than a long term rental property.
The profitability of any vacation home or short term rental (STR) relies heavily on a variety of different factors. Here are Simplify STR, we use market data and industry trends to help our customers locate the most profitable short term rental opportunities. Some of the various factors that need to be considered before making any purchase:
Real Estate Market Trends Are Favorable
Rising Interest Rates are Driving More Favorable Conditions:
Throughout 2020 and 2021 interest rates remained historically low. Now, interest rates have started to rise. While rising interest rates is generally a bad thing for buyers, it almost comes as a relief to short term rental investors. With the higher interest rates the pool of buyers has decreased and home prices have steadily started to drop – a trend we expect will continue. This also gives a buyer more negotiating power to make sure you are getting a property at the price point you need to hit your target cap rate.
Shifting Towards Buyers Market:
The market has slowly started to shift from a sellers’ market to a buyers’ market. Throughout the nation home prices increased by an average of almost 17% in 2021 - the highest on record. Not only that, but homes were often selling for more than the asking price. In recent months, asking prices have started to come back down to earth. Many of the currently listed properties are posting reductions and properties are staying on the market longer. The additional supply plus the decreased pool of buyers is slowly shifting the market to be more favorable to a buyer.
Supply and demand:
Every city is completely different when it comes to short term rental supply and demand. You’ll want to do your research to ensure you are buying in a spot that has a competitive occupancy rate, as well as one that has a high average nightly rate. This can change dramatically from one city to the next, so understanding the data is important. Services like AirDNA can provide this data, but it can be costly and can sometimes provide misleading figures. That's why our team works with our client to ensure we not only have accurate data, but helps to understand what that data means.
Some areas can vary dramatically in profitability throughout the year. A house that sits on a ski resort will obviously be much more profitable in the winter than it will in the summer. However, that doesn’t make it a bad investment – just something that needs to be considered and accounted for before buying. A city like Chicago is extremely popular in the summer, but has very slow winters. And alternatively, a city like New Orleans is the opposite - people avoid the brutally hot summers and flock there in the winter (especially during festival season). Knowing your market and how the profitability can change throughout the year is important.
This is a big one, and something that is constantly changing. Cities are constantly changing short term rental regulations. This can sometimes be prohibitive to outside investors if you look in the wrong city. Check all of the local laws and regulations before you buy any property to ensure you are legally allowed to list a short term rental in that area. There are still plenty of popular cities that are favorable to STR investments. However, some are starting to make it more restrictive. New Orleans, for example, is an extremely tourist friendly town that has been extremely profitable for short term rental owners. However, New Orleans recently implemented various regulations which has made operating an STR much more difficult – especially for outside investors.
Short term rental investments are often considered to be a commercial investment, which changes the mortgage options. If you don’t plan to live in a home yourself many mortgage providers require a 20 – 25% down payment. Additionally, you can expect another 3-5% in closing costs. This can make for a costly up-front investment.
The going rate for short term rental management companies is generally around 20-30% of the revenue. This can quickly eat away at the profitability of a short term rental and is critically important to include in your cap rate estimations. In addition to management expenses, you need to make sure to account for other large expenses: Rental/lodging taxes, property tax, turnover and cleaning services, insurance, utilities, licenses and permits, etc… Many of these are city-specific, so again – make sure you understand local regulations before buying.
The rule of thumb in the industry is to seek a cap rate of 5-10% when looking at real estate investments. However, in today’s marketplace there are plenty of opportunities that can capture a cap rate of 20% or more. You just need to have the right data and know where to look.