How to Invest in Vacation Rentals

If you’re looking to break into real estate investing, the time is now. Some of the highest-demand vacation rental markets have seen revenues increase 70% or more over the past year, according to Realtor.com.

The good news is market statistics confirm that 2022 is a great year to embark on this journey. According to AirDNA, listings in US cities and resort markets are expected to rise 15% in 2022 over 2021. There is an expected 14.1% increase in demand for vacation rentals globally in 2022 compared to 2021. In urban areas, demand is expected to grow by 33%, since these areas have been hit hardest by the pandemic. Additionally, Statista predicts that worldwide revenue from vacation rentals will reach US$81.143 billion by 2022, with most of that coming from the US ($17.660 billion).

Purchasing a property involves a certain amount of risk. The entire process is often overthought. Taking the time to plan and conduct background research is important, but do not become overwhelmed by the results. If you're looking to buy a vacation home, this article will hopefully provide you with some valuable information and insight into what to consider.

Investing in vacation rentals: Is it a good idea?

In a recent survey of over 5,000 travelers, 86% of participants said they plan to book a vacation rental for their 2022 adventures. VRBO statistics indicate that pandemic-influenced travel habits are here to stay. Accordingly, 61% of families who answered the survey said they would rather go to an outdoor destination than to an urban one, 59% would rather drive than fly on their next trip, and 52% said they would do it again if given the opportunity.

Vacation rental 2022 trend reports show that short-term rentals are becoming increasingly popular and that people are traveling differently, and this trend is here to stay. So it is safe to state it is a wise and timely investment route to take in terms of where you invest your money and within a short span of time generate the income potential if you do it right.

Advantages of Investing in Vacation Rentals

1. High Income Potential

There are currently unprecedented income opportunities in the vacation rental industry, and its rewards are high.

Capitalization Rates, also known as cap rates, are measures used to estimate and compare the rates of return on commercial real estate properties. Cap rates are calculated by dividing the property's net operating income (NOI) from its property asset value.

__CAP RATE = NET OPERATING INCOME / CURRENT MARKET VALUE OF ASSET __

This indicates return on investment. Short-term rental cap rates can often exceed 10% in metro markets, while long-term rental cap rates typically hover around 4-5%.

Vacation rentals have a much higher potential for profitability than other property options, allowing for a whole lot more money to be made.

2. Investment Appreciation

Property appreciation is one of the biggest perks in real estate investing. A property's value can double over a period of time in the real estate market as a result of the high market demand. And If you decide to sell your vacation rental property at some point, you can almost always expect a good return on your investment. In most cases, vacation rental properties are widely sought after, so their values usually increase over time.

3. Tax Benefits

A vacation rental investment has similar tax benefits to a primary residence. Mortgage payments, property taxes, furnishings, maintenance and repairs, advertising, rental income, insurance premiums, and other expenses may qualify for tax deductions.

If you are interested in understanding vacation rental investment tax codes and tax deduction eligibility for your rental home, a certified public accountant can assist you.

4. Increasing Market Size

Nearly every market in the U.S. offers vacation homes, from small towns and villages to large metropolises. Statistics shared via ipropertymanagement claim the number of vacation rentals in the U.S. is currently over 1,985,280 million, and the number of available vacation rental listings is projected to increase by 20.5% by 2022. Statista predicts that there will be 893.7 million vacations, and rental users, by 2026, with a penetration rate of 9.2% in 2022 and 11.3% in 2025.

5. Vacation Getaway for Personal Use

Vacation rental properties are useful for business and pleasure, which is one of their greatest benefits. Spend some time with the family away from home. Organize fun events for your family and friends.

Potential Drawbacks and Challenges

Vacation rentals can have drawbacks, but these disadvantages can be minimized by choosing the right market and hiring a property manager if your budget allows it.

1. Managing a vacation rental is a full-time job that requires hard work and commitment. Managing a vacation rental can be challenging due to the frequent turnover of guests - you must always be prepared.
2. In comparison to owning a property rented to a long-term tenant, vacation rentals may generate inconsistent income due to seasonality and increased competition.
3. The marketing of a vacation rental includes listing on the top short-term rental platforms, coordinating guests and calendars, stocking supplies, and furnishing a home.
4. It's important to understand the rules before investing in a vacation rental home. Local municipalities and HOAs may restrict or can prohibit vacation rentals. To find out what they are prior to deciding on location + property.
5. You will have to pay more for financing your vacation rental investment, which is probably the biggest downside. Mortgage interest rates tend to be higher for investment properties than for other types of loans. Therefore, your monthly payment and interest will be higher over the loan's lifespan. The down payment will also usually be higher, usually around 25%.

Costs associated with Vacation Rentals

Your business's growth and success depend on understanding basic financials and vacation rental expenses. You should start by determining your revenue, costs, and profit. Revenue is the value of your bookings and room nights, as well as any additional fees and add-ons you sell. Profit is the difference between your revenue and all of your costs. Having a good understanding of your costs will help you determine how profitable your business will be.

Vacation Rental Expenses: Major Cost Categories

1. Mortgage costs, Strata Fees, Insurance Policy fees, Property Tax
2. Marketing Costs & OTA Fees - eg : Airbnb 3% VRBO 10% Booking.com 15%
3. Cleaning & Maintenance costs (contractors, products, and amenities replenishment)
4. Startup Costs - Decor, Furnishings, Linens, and some Miscellaneous
5. General Services (utilities, phone, Internet & wifi, TV subscriptions)

Setting up an Emergency Fund

A vacation rental emergency fund is a must. There can always be unexpected repairs or appliance replacements. Put aside a fund that will only be tapped when necessary.

When it comes to your vacation rental, set up separate bank accounts for your transactions. Ideally three bank accounts:

1. an operating account (for mortgage payments, rent, taxes, and insurance),
2. a security deposit account for each rental property,
3. one for general emergency funds.

Essentially, add up your monthly mortgages, insurance premiums, taxes, operating utilities, and possible rental fees. Multiply it by three and cut this figure in half. The number you get is a good gauge for your minimum emergency fund.

A couple of ways to fund your emergency fund are,

1. set aside a portion of your monthly income and save that money.
2. you could set aside 10 percent of the rental income you receive on a monthly basis.

In the beginning, saving can be difficult, but you'll soon get the hang of it and enjoy the security net.

Investing in Vacation Rentals: Key Factors to Consider

A variety of factors should be considered before deciding which short-term rental property will be most profitable:

1. Location

First, find the location where you would like to set up your vacation rental - then search for the property. A short-term rental's profitability is heavily influenced by location. Before evaluating individual properties, it's important to determine the location that meets your needs. The ability to attract a consistent flow of guests is just as important as the property purchase price.

Investing tip: Explore the top vacation rental investment locations in the U.S. or start your search in a location that interests you. Do your research - use interactive forums on Facebook, or LinkedIn as well as useful sources such as AirDNA, AllTheRooms or Transparent. When conducting your research, pay attention to key metrics such as occupancy rate, average daily rate, RevPAR, and length of stay. It's possible you won't end up where you started, so be open to new possibilities!

Earmark these points too

• For business travelers, urban rentals may be the best option
• A leisure traveler may find it more convenient to rent in a small tourist destination.
• Laws and regulations governing short-term rentals vary by location

2. Market Demand

The quality of a vacation rental must be high enough to attract both first-time and repeat guests. Vacation rentals are different from regular long-term rentals because they have to be a more defined target audience. In any business that involves real estate, you should be aware of who your property is for and what to anticipate throughout peak seasons, as well as off-seasons. Establishing and understanding your market demand is an essential part of the success of your vacation rental.

3. Seasonality

In areas with high and low seasons, vacation rental properties are often in demand at different times of the year. Vacationers may book a short-term rental near the beach during the summer, whereas business travelers may rent a short-term rental in a large city all year round.

4. Occupancy

An occupancy rate for a vacation rental is determined by dividing the number of nights occupied by the number of available nights.

The size and number of bedrooms and baths, amenities, and proximity to outdoor attractions can all contribute to keeping a vacation rental occupancy rate high.

5. Return on Investment

The ROI of a property can show you how much a property is likely to earn after all expenses, fees, and taxes have been paid. In a market where tourism is always fluctuating, an ROI calculation can give you a clearer picture of your investment. Essentially, it means how much profit you will receive in return for the cash investment made. Your return on investment (ROI) is typically calculated as a percentage of the total investment cost.

ROI Calculation

This is the most basic calculator and looks at the rate of return.

ROI = (Income from Investment – Cost of Investment)/Cost of Investment

Key Takeaways

Vacation rental investments are a great way to gain passive income. Jumping in headfirst without a plan isn't safe. Before taking the plunge, do your due diligence and know what you are getting into.

Investing in a vacation rental offers a wide range of benefits, including access to a hugely diverse market, generating extra income, and benefiting from tax advantages. In contrast to long-term rentals, vacation rental properties have a greater rate of guest turnover, require well-equipped and furnished homes, and may be prohibited by local laws or homeowner associations (HOAs).

Attention to detail can make all the difference in terms of your return on investment. The right preparation can lead to significant profits and a successful vacation rental career in the long run.