Buying a Vacation Home as an Investment Rental Property – Pros & Cons

It sounds so sexy: buy a vacation rental property to rent out for most of the year, and occasionally use it yourself just for fun.

And it can work out well — if you go into it with the mindset of operating a hospitality business. If you go into it starry-eyed, daydreaming about buying a second home and getting other people to pay for it, prepare for a rude awakening.

Managing a short-term rental property takes a lot of work. You can outsource that work to a property manager, but it will cost you. In fact, most new vacation rental owners are surprised by just how many expenses they incur as a landlord.

But owning vacation rentals comes with advantages too, beyond the “chic” factor. Here’s what you need to know before buying a short-term rental property.

Pros of Short-Term Rentals

Done right, short-term rentals can be profitable, tax-friendly, and downright fun investments.

As you start exploring the vacation rental industry, keep these advantages in mind, and aim to maximize them as much as possible.

1. Passive Income

Rental properties, whether leased short-term or long-term, make an excellent source of passive income. If you buy at the right price and manage them effectively, that is.

My friend Zack averages nearly $1,000 per month in cash flow from his Airbnb rental. It’s not in some fancy resort town either; it’s in downtown Baltimore. Originally he lived in it, then he moved out and converted it into a long-term rental. But he ran the numbers and discovered he could earn more each year operating it as an Airbnb rental.

You don’t have to buy an oceanfront bungalow or ski chalet to get into the vacation rental industry. Forget the image of being a vacation rental owner, and focus on the cash flow.

Because when you do your homework and learn the ropes, rental properties offer a time-tested strategy for earning passive income.

2. Appreciation

Rental properties don’t just provide ongoing cash flow. They also typically appreciate over time, raising your net worth and building equity with little effort required on your part.

Critics are quick to point out that appreciation is not guaranteed, and they’re absolutely right. But declining property values are rare over the long term, and it’s just as common for real estate values to leap upward in value faster than average as they are to appreciate slower.

Although it shouldn’t be your primary reason for buying a vacation rental, appreciation usually provides additional profit when it comes time to sell. And even as your property rises in value, your renters pay down your mortgage, leaving an ever-expanding equity gap between what you owe and the property’s value.

3. Lower Risk of Rent Defaults & Evictions

Long-term tenants can be a nightmare. From not bothering to pay the rent to trashing your property, dealing with bad tenants often drives landlords to sell and never look back.

As a vacation rental owner, you collect the rent upfront. If their payment fails, so does their booking.

This means you don’t have to worry about landlord migraines like having to evict bad tenants.

There are a few exceptions. If your guests stay longer than a month or two, they may gain squatters’ rights, forcing you to formally evict them (rather than just calling the cops) if they refuse to vacate. But that kind of bad behavior proves blessedly rare in the vacation rental industry.

4. Ever-Improving Automation

You can automate a lot in today’s world, including most of your guest interactions and the check-in and check-out process.

For example, Airbnb lets you auto-approve bookings without manual oversight if you like. Or you can manually review guests’ profiles before approving them.

A few days before your guests’ arrival, you can send a template message with instructions for entry. The guests arrive, and they can access the property with a key code, hidden key box, smart lock, or whatever other automated entry systems you’ve implemented.

You can leave them a welcome packet on the coffee table with crucial details like the Wi-Fi password and which local cafe offers the best almond skim latte. Include instructions for where to leave the key when they check out and send an automated reminder message the night before.

You can then send a brief series of exit messages thanking them for their stay, and requesting they leave you a review —all going out automatically, or at least saved as template messages. All you need to do is send in the cleaners afterward, which can easily be done through Handy.com.

5. Tax Benefits

Rental properties of any tenancy duration come with some great tax advantages.

All relevant expenses are deductible of course, including mortgage interest. You can even deduct some paper expenses that don’t cost you cash, such as depreciation.

Best of all, those deductions come off your rental profits and don’t require you to itemize your deductions. You can take them on top of the standard deduction.

Owning a vacation rental property might even let you get away with writing off the occasional visit to it — purely to check in and do some maintenance, of course.

When you go to sell the property, you can avoid capital gains taxes on your profits by doing a 1031 exchange. There are a lot of ways to lower your tax bill as a real estate investor, but be sure to check with a tax professional first.

6. You Can Use the Property Yourself

It’s dangerous to mix business and pleasure. People tend to make emotional decisions and then twist together some dodgy logic to justify them. “This beach house in Naples? Don’t be silly, I’m not buying it for me. It’s an investment!”

With that caveat in mind, you can occasionally use your short-term rental properties for yourself. Who wouldn’t love to own a vacation property?

Just make sure you buy based on cash flow first and foremost. If the property happens to be in a location you’d enjoy using yourself, well, that can be fun too.


Cons of Short-Term Rentals

For all these advantages, vacation rentals also come with their fair share of risks.

Most of the risks can be mitigated, but it takes some knowledge, work, and discipline on your part. Here’s what you need to be aware of when buying and managing vacation rental properties.

1. Risk of Poor Cash Flow

New landlords who don’t do their homework get a nasty surprise when they eventually realize just how many expenses they incur every year.

I can’t tell you how often I’ve heard people say “Well, the rental income is $1,500, and the mortgage is only $1,000, so I’ll clear $500 a month.” That investor is about to lose their shirt.

Beyond the principle and interest payment on the mortgage, other landlord expenses include:

  • Property taxes
  • Property insurance
  • Vacancy rate
  • Property management fees
  • Repairs and maintenance
  • Cleaning costs (in the case of vacation rentals)
  • Furniture (in the case of vacation rentals)
  • Bookkeeping, accounting, administrative, and travel expenses

It adds up quickly. Additionally, vacation rental landlords suffer far higher vacancy rates than traditional landlords. Vacancy rates are uneven and subject to seasonality. The summer high season might see 90% occupancy rates, but what about the offseason?

Before buying a vacation rental property, sit down with a spreadsheet and a phone. Keep calling local property managers until you get accurate numbers for each of the expenses above, and fill them into your spreadsheet. Pay particular attention to the vacancy rate, collecting accurate numbers for every single month of the year.

Then, and only then, you can accurately forecast your average annual cash flow.

2. Risk of Regulatory & Tax Burdens

Not every city and state loves the vacation rental industry.

For that matter, the hotel industry hasn’t just politely moved aside to welcome the disruption caused by Airbnb. They’ve spent millions of dollars to lobby against home-grown vacation rental owners, largely on the local level, but The Hill reports that the industry spends millions in federal lobbying dollars as well.

In many markets, it has worked. Some cities and states impose their own custom rules, regulations, and taxes on vacation property owners. For example, some cities and states require mom-and-pop vacation property owners to pay hotel or sales taxes. Others require them to get a business license.

Some places virtually outlaw Airbnb and mom-and-pop operators. Santa Monica, California, for example, wiped out 80% of the local Airbnb market through its combination of taxes and regulation, according to Forbes.

Before buying a vacation rental, do your due diligence on the local laws impacting vacation rental owners. It’s not enough to know the current laws — you also need to prepare for changing regulations in the future.

Protect against future regulation by running the numbers on the property as a long-term rental as well. You should always have a contingency plan ready as a real estate investor.

3. Risk of Damage

Renters can damage your property whether they stay one night or one year. It’s simply a risk of becoming a landlord.

One way landlords mitigate this risk is by collecting a security deposit. But as anyone who’s seen “Animal House” can attest, your renters can easily do more damage in a single night than the security deposit can cover.

Using platforms like Airbnb, you can also screen renters by reading prior hosts’ reviews of them. While this can help you spot a habitual damager, it’s hardly foolproof. It also requires you to either turn off Instabook or cancel on sketchy guests after they book, which creates an automated review on your property stating that you canceled a booking.

While you should collect a security deposit and check guests’ reviews, you should also set a generous budget for repair and maintenance expenses.

4. More Labor Than Long-Term Rentals

Even if you automate the check-in and check-out process, you can still expect more property management labor than a typical long-term rental property.

After all, turnovers are where landlords see most of their labor. And vacation rental properties see a lot of turnovers.

You can outsource this labor to a property manager if you like. Or you can do it yourself, in which case you should pay yourself for it just as you would pay a property manager. It’s a labor expense regardless of who’s doing the labor, and you should account for it.

5. Furnishing & Decorating

Long-term landlords don’t have to furnish or decorate their units. Vacation property owners do.

That adds to your expenses, both initially and on an ongoing basis. Your guests will cause wear and tear on your furniture, and occasionally break the décor. So these costs need to be in your budget of expenses.

Of course, no one says you have to buy brand new furniture or art. Your guests certainly don’t expect to be the first people to sit on the couch or sleep in the bed. Furniture is one of the many things you should always buy secondhand, especially in the context of vacation rental properties.

You can even use some of your own furniture you’ve outgrown, giving it a second life.

Just make sure the furniture and décor are tasteful and cohesive. When in doubt, call up a friend with impeccable taste and ask their opinion for some free interior decorating insight.


Final Word

Short-term rental properties can make excellent sources of passive income, tax benefits, long-term appreciation, and the occasional getaway. But they can also cost you dearly if you fail to analyze the cash flow and regulatory requirements, or if you manage them poorly.

Be especially careful to avoid getting caught up in the idea of owning a vacation rental, and buying because you’re excited about it rather than because the cold, hard numbers make sense. This property is an investment first, and a vacation retreat for you second.

Keep in mind that renting the property by the night or week aren’t your only options. You can offer it as a seasonal, month-long, or a corporate rental. This is something travel nurses look for, for example. You can — and should — run the numbers on renting the property to long-term tenants as well, if only as a contingency plan in case the laws or market conditions change.

Run the numbers carefully, approach your rental properties like a business, and protect yourself vigilantly so you can create a fun side business offering low-cost, tax-friendly vacations.

Why are you thinking about buying a vacation rental property? What are your concerns?

 

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