Original Article Date: September 15, 2022
9 Steps To Investing In Your First Short-term Rental
We often get asked on how to identify the right short-term rental investment. While there are countless articles on the internet on various aspects of short-term rentals, none of them provides a framework for thinking about investing in this asset class. To that end, we decided to share our framework for investing in your short-term rental so you can learn from our successes, and failures over the $15M+ worth of short-term rental deals we have done in this 5 part series. In each part, we will dive deep into specific steps of this 9 step journey so you can follow along and learn more.
The 9 key steps, summarized
The first step of every investor is to identify the purpose of your investment, which we expand in the below section. Once the investor identified has their purpose of investment, they will need to identify the markets they wish to invest in (Step 2). In step 3, we explain how the savvy investor can model the risk and return profile of each market, and choose the market they wish to invest in.
We recommend investors to combine step 4 and 5 together: investors need to find their realtor, and property manager early on. While a realtor may give specific information about purchasing homes, the property manager will inform the investor of what a good short-term rental home is, and how much it will generate. We often see investors overlook finding property managers till the last minute, only to realize the property will not generate the cash flow they expected as the realtor did not understand the market well and sold them a bad product. Investors often find it helpful to find a realtor who also manages properties to deliver the maximum possible returns with a knowledegable realtor specialized in short-term rentals. We provide in house realtor and property management services to our clients to ensure that our clients are able to find the highest performing short term rentals in each market to deliver maximium returns.
Once an investor has identified the right investment, they simply need to pull the trigger and proceed with purchasing their home (Step 6), and fix, furnish the home for as a short term rental (Step 7). Once the home is live, the investor can sit back, and let the property manager take over fully and monitor their performance, while ensuring the home is maintained well.
Step 1: Identify the purpose of Investment
The first step begins with identifying the purpose of their investment. Some investors choose to buy it to maximize cash flow returns, whereas others may wish to mostly use buy a home as their vacation home in a destination they visit often, and rent it out for the rest of the year. Some investors want to have the vacation home nearby so they can potentially self-manage it, whereas others want to be as hands-off and leave it to professional property management companies anywhere in the country. Regardless of the approach, investors want to ensure their investments are aligned with their interests.
Define your purpose for STR investment?
- Is it your vacation home? Pure investment?
- Nearby to where you live or far off?
- Self-managed or property manager?
Personally, we recommend investors to focus on purchasing short term rentals in locations that maximize cash flow returns, as they can always use that cash flow to rent a vacation home elsewhere, and not be tied to vacationing in a certain destination every year.
For example, we often see investors come to us for advice on investing in Orlando short-term rentals - close to Disneyland as they may have young children and may want to visit every year. We dissuade investors from this as the Orlando market restricts short-term rentals. Most investors buy in Kissimee, close to Orlando instead. Additionally, the nightly rate of the market is incredibly low as many other investors also had the same idea, and bought vacation rentals, driving up home prices, and driving down short term rental prices, and thus returns. Additionally, there is heavy competition from hotels, which drives down returns even further.
Instead, we recommend investors to check out nearby cashflow positive markets of Tampa, Fort Lauderdale etc. Homes here are still only 3 hours away from Disneyland, but the returns are much higher due to lower competition from less supply.
The choice of using a property management is a tricky one for most investors - sometimes managing it by yourself may lead to slightly higher returns as you can avoid the management fees, but it can also backfire. The novice investor may end up spending a lot more time than anticipated to learn everything from scratch, typically 80-120 hours to make the home go live and then 3-5 hours/week for ongoing monitoring, messaging, communication, pricing, repair & maintenance, dealing with cleaners, contractors etc. Additionally, these roles are require you to be on-call: if guests message you in the night time, you need to respond. If an emergency happens to the cleaners, you need to head and clean the home. If you notice a leak in the night, you will need to go and fix it as contractors won't be available.
Even then, returns may not be guaranteed - managing a short-term rental is more similar to managing a hotel, than a long a term rental. Because of that, we see a wide variation of returns across the market. For example, Nicasa makes 2.5X than the average short-term rental in Seattle. The investor needs to think if the incremental returns are worth the additional work. An easy way to quantify it is the amount of $/hour they will be making - and whether it's higher than their full time job.
In the next step, we cover how to identify markets to invest in.
Step 2: Identify markets to invest
Once an investor has identified their purpose of investment, they should start narrowing down to specific markets of their liking. If the investor is choosing as their vacation home, then the answer is simply the destinations they want to travel consistently and finding the right one that makes sense for their needs.
If the investor is looking as a pure cash-flow investment, there are multiple ways to go about this. We follow a data driven approach to investing. A general rule of thumb is to maximize Revenue/Home Price ratio while minimizing risk. In this step, we focus on identifying this revenue/price ratio and in next step, we dive deeper and model cash flow returns and identify risks in the next step.
The rule of thumb is to maximize Revenue/Home Price Ratio while minimizing risk.
To generate this ratio for multiple markets, investors can start their search by identifying and comparing revenue of different markets through resources such as Airdna. To ensure you are comparing apples to apples, we recommend comparing revenue of 3-4 bedroom homes across various markets, which is the typical median home size for most markets.
Since revenue only gives one side of the picture, investors also need to layer in home prices on the denominator to get a good understanding of the returns of the market. You can get median home prices through public data sources such as MLS, Redfin, or Zillow for each market.
Through this, investors can find and sort markets with high revenue/price ratios and focus on building cash flow models and identifying risks of each market.
Step 3 and Beyond
In the second part of our series, we discuss how to model short-term rental investment returns here. To jump further ahead on how to find the right property manager, check our third part of the series here.
Stay tuned for more content for the remainder of our series!
Curious to learn more about finding the right short-term rental investment for you? Book a free 15 min consultation by contacting us here.