When home buyers consider a second home as a real estate investment, most typically consider long-term rentals. While this can be an excellent option, sometimes you may want a property in a different city that you can visit frequently but also rent out for the short term when it’s empty. Or perhaps you’ve spotted a solid investment opportunity in a holiday town, and while you’d love to retire there, you’re not ready for it yet.
Vacation rentals can be a fantastic way to make income from an investment property while also using it for short-term holidays or as an addition to a retirement portfolio. And with the arrival of Airbnb in 2008 and the rebranding of Vrbo in 2019, the opportunity is rife. An increasing number of travelers are ditching old-school hotels and resorts for more unique and intimate experiences. 19% of travelers who booked a vacation rental between March 2020 and April 2021 were doing so for the first time. If you’re looking to buy a second home or have a spare bedroom to rent out, vacation rentals can be an excellent investment opportunity.
What are vacation rentals?
Vacation rentals are furnished apartments, houses, or professionally-managed resorts or complexes that are rented out, often to tourists, as an alternative to hotels. These short-term rental properties are stocked with basic amenities, and the stay is usually no more than 30 days.
Short-term vacation rentals have become incredibly popular over the last few years. According to Vacasa’s Vacation Rental Search Report, traffic and searches for vacation rentals were more than double year over year—by spring 2021, searches were up 235%, and their number of users was up 116%. For investors, vacation rental revenue can be a valuable income source. According to Vrbo/Homeaway, vacation rental income comprises 24% of the average owner’s annual income.
The pros and cons of investing in vacation rentals
Vacation homes can be an incredibly lucrative investment, especially for Instagram-worthy properties in desirable and well-frequented locations. In October 2020 alone, Airbnb hosts earned over $100 billion in rental income globally. However, investing in the vacation rental market differs from renting a home to long-term tenants. While that can prove exciting—and profitable—it also requires more attention and upkeep. Here are some pros and cons to keep in mind when considering investing in a vacation rental.
Vacation rental property websites such as Airbnb, VRBO, and HomeAway have changed people’s travel. Instead of impersonal hotel rooms, travelers are now willing to pay a premium for vacation properties that offer an experience—as a vacation rental property owner and investor, having a home in the right location can be highly lucrative, especially in the high season. How much a vacation rental will earn can vary on location, size, and amenities. Still, research shows that vacation rentals are responsible for 130% more revenue on average than traditional long-term rentals.
A vacation rental can act both as an investment as well as a holiday home for a quick getaway. Days or weeks when you plan to use the property as a second home can easily be blocked off as unavailable, allowing you to take advantage of investing in the real estate market while also having a property to use as a vacation home.
A vacation rental property would be considered a vacation rental business, which means there are substantial tax deductions and benefits to owning a vacation rental that is primarily used as an investment. Most expenses to do with the property are considered tax write-offs, including maintenance and repair costs, insurance, property management fees, marketing costs, and mortgage interest.
Not only does a vacation rental offer short-term passive income in rent payments, but it also appreciates over time. In short, if the property were to be sold, the appreciation would guarantee a high return on investment in addition to the monthly income the property provides. The short-term rental market in desirable locations tends to show a faster growth trajectory and higher rates of return in the long term.
Likely to survive recessions
The real advantage to buying property—and the reason it’s such a good investment—is that people will always need a place to live. Likewise, research shows that even during a recession, people continue to take vacations, even if they’re planning shorter trips, sharing expenses, and booking holidays closer to home.
Vacancies and inconsistent income
Vacancies are a fact of life with vacation rentals, and there will be days where the property sits empty during the off-season, especially if the vacation rental is seasonal. This is to be expected, and the high revenues on the days when the property is occupied often offset the days it is vacant. However, if a property stays empty for too many days of the year, it can impact cash flow.
Due to the nature of a vacation rental, where a property must be cleaned and amenities refilled and rechecked after each stay, the expenses can add up. If you hire a property management company, those fees can also eat into the rental income. Other expenses include supply costs, cleaning costs, maintenance costs from wear and tear, and utilities.
A short-term vacation property will require more management, marketing, and time spent on booking than a long-term rental. Overseeing cleaning and maintenance, preparing the property, restocking essential items, marketing, organizing bookings, responding to guests and renters, and arranging check-ins and check-outs are some of the daily activities that need to be done with a vacation rental.
How to choose a suitable vacation rental investment property
The key to a vacation rental investment property that will continue to create cash flow and appreciation, in large part, comes down to the choice of property. Here are some things to keep in mind as you start looking for potential investments.
Location: This is possibly the most crucial decision when purchasing a vacation rental. The location where you are buying can often come down to personal factors, such as where you plan to take summer holidays or if there’s a particular state or city where you’d like to retire. However, from a pure investment perspective, you might want to look at the hottest markets with the highest profit margins. A report by AirDNA listed the best places to invest in vacation rentals for 2021 and 2022. Areas that stood out as up-and-coming markets were the Appalachian mountains, northern California, Minnesotan lakes, and upstate New York. The cities with the top investor scores were:
- Maui, Hawaii
- Kenai Peninsula, Arkansas
- Chattanooga, Tennessee
- Gulfport/Biloxi, Mississippi
- Slidell, Louisiana
- Crystal River, Florida
- Joshua Tree, California
- Charleston, South Carolina
- Galena, Illinois
- Southwest Harbor, Maine
Between April 2019 and April 2021, vacation rentals in small and mid-sized cities, destination resort towns, and rural areas saw demand increase between 8% and 67% over the two years.
Rental demand: Rental demand is a combination of annual occupancy and listing growth rates. When evaluating a potential property for purchase, you want to look at the seasonality of the property, that is, is the property in an area that sees visitors all year round, or is it more suited to summer or winter tourists? For example, a property near the beach is likely to see higher demand during summer, whereas one near a ski resort may only have visitors during winter. This will help you determine the occupancy rate, the number of nights a vacation rental is booked divided by the number of nights available, and decide whether or not it’s high enough to cover your mortgage payments and perhaps even make a profit.
Expenses: Make a list of the monthly and annual recurring costs for maintaining the property. This will include cleaning, restocking supplies, hosting fees, property management fees, and marketing. You’ll need to know if, given the occupancy rate, the costs remain low enough for this to be a reasonable investment.
Investing in a vacation rental vs. buying a second home
If a homeowner does not attempt to rent a property and keeps it solely for their personal use, it is, in the eyes of the IRS, a second home. However, any property owned for investment purposes, such as a vacation rental, is considered a rental home and taxed differently.
- With a dual-use property, such as a vacation rental that you occasionally use for personal purposes, the IRS requires you to split your use to calculate tax.
- When you sell a second home for profit, you will be required to pay capital gains tax on your profit. (To avoid this, you would need to make this your primary residence for two years.) However, when you sell a rental home, you don’t have to pay capital gains taxes if you plan to reinvest the funds into another investment property.
Easily invest in vacation rentals
Vacation rentals can be an excellent real estate investment with low barriers to entry and many tax benefits. Given the high demand and prices for specific locations, you’re likely to have a property that provides consistent year-on-year cash flow while appreciating considerably in value.
Our mission at Arrived is to give real estate investors opportunities to invest in homes and take advantage of property appreciation and rental income without the hassle of finding, maintaining, or managing a property. Our fractional real estate investing model helps to take advantage of higher rates in housing markets in the hottest locations with no significant down payment or upfront costs. Look through the properties available to get started with Arrived.