Are Vacation Rentals a Good Investment?

Are vacation rentals a good investment? This question has been on the minds of many individuals looking to diversify their investment portfolios. The answer largely depends on various factors such as location, demand, management, and overall market conditions. Vacation rentals can offer a unique investment opportunity with the potential for high returns, but it also comes with its own set of challenges and risks.

Vacation rentals can be a good investment for those willing to put in the effort to manage the property effectively and navigate the challenges of the rental market. Conducting thorough research, understanding the local regulations, and creating a solid business plan are essential steps for anyone considering investing in vacation rentals. With the right approach and diligence, vacation rentals can offer a potentially lucrative investment opportunity for investors seeking to diversify their portfolios and generate passive income.

What Are the Pluses of Vacation Rentals?

There are several advantages of vacation rentals, some of which are discussed below:

Profit and Revenue

The most obvious potential plus of investing in vacation rentals is revenue. It’s not uncommon for high-end vacation rentals in popular markets such as South Florida or Southern California to gross upwards of $20,000 per month or more. In many cases, vacation rental owners in highly sought-after markets can make enough money during peak travel season to make an entire year of mortgage payments and still earn a tidy profit.

To be certain, a vacation rental that garners that kind of income would definitely be in the luxury category, but even small to medium-sized apartments or condominiums can generate impressive returns for investors. Perhaps more importantly, the success of vacation rentals is popping up in places where there may not have previously been a strong demand for them.

Opportunity in New Markets

Suddenly, people who own second homes in cities like Nashville, Tennessee, or Branson, Missouri, are netting impressive returns by offering vacation rentals to tourists who come to see the various musical attractions that make those cities famous. People who own vacation rentals with easy access to national parks or nature preserves are also seeing strong revenue.

In many cases, the ability to advertise on platforms like Airbnb has been a godsend. Vacation rental owners in some of these previously underrepresented areas get a double benefit of being able to command high prices for properties that cost much less money than comparable vacation rentals in Los Angeles or San Francisco.

Flexibility and Tax Benefits

Another huge advantage of vacation rentals as investments is the flexibility they offer investors. In years past, acquiring a vacation home in your favorite travel destination was something that didn’t necessarily make much sense. Paying the mortgage, property taxes and insurance all year for a property you might visit for just two or three months was an expense that only 1% of users could really justify.

Now, you can turn those properties over to a vacation rental platform or management company and they could easily pay for themselves. Additionally, if you set the property up as a limited liability company (LLC), you can get some significant tax benefits on the annual income. The 2017 Tax Cuts and Jobs Act allows you to take a 20% tax write-off on the pass-through income from your LLC.

You can also write off all the annual expenses associated with running the rental. Examples of the kind of expenses you can write off include:

• Mortgage
• Property taxes
• Insurance
• Management fees
• Capital improvements
• Utilities
• Ancillary services such as cleaning and landscaping

What Are the Potential Drawbacks of Vacation Rentals?

While vacation rentals offer unique and often cost-effective accommodations for travelers, there are some potential drawbacks to be aware of.

Acquisition Cost

There is no such thing as an investment opportunity without a potential downside, and vacation rentals are no different. Obviously, the income a vacation rental in a sought-after market can earn during peak season is impressive. However, properties in these markets are generally very expensive.

If you want to earn a five-figure monthly income on your vacation rental, you’ll probably have to spend upwards of $1 million to acquire it. In fact, you’ll probably have to spend much more than that if you’re looking in the top markets such as The Hamptons, New York; Malibu, California; or South Beach, Florida. That is a lot of money — especially if you’re already carrying a mortgage or other expenses, such as kids in college.

Related: How to Finance an Airbnb

Ancillary Expenses

Secondly, if you’re going to have a vacation rental, you’ll have a lot of ancillary expenses. You will have to manage it yourself or pay someone else to manage it. If you’re thinking of self-managing your property, bear in mind that travelers can be very demanding. As a general rule, the more you’re charging for your vacation rental, the more demanding your tenants will be.

If you opt for private management, that’s only one of your potential expenses. You will also need to furnish your vacation rental. Again, you must keep in mind that if you want high revenue, you’re going to have to go with high-end fixtures and furniture. You will also more than likely need a cleaning service. If you don’t have one, you’ll be running back and forth to keep the place clean, and there is a huge difference between a rent-ready professional cleaning job and standard house cleaning.

Needless to say, all of these expenses will eat into your monthly profit. That’s a big part of why vacation rentals charge travelers such a high premium. So, you’re going to have to keep a watchful eye on your expenses because a high monthly rent means nothing if you spend more than you make.

Seasonal and Sporadic Income

Depending on where your vacation rental is, you may only have a short high season where you earn the big revenue. There will also likely be several competing vacation rentals in the area, and you’ll all be fighting for the same tourist dollars. So, you may make good or even great money for some of the year and little to no money for the rest of the year.

Granted, that’s not as much of a consideration in West Coast locations like Los Angeles or Sun Belt cities like Miami where vacation season never ends. However, it’s still a safe bet that your short-term vacation rental won’t be occupied all year. So, you always have to factor in the reality that you may only make money for half the year, or even just a few months per year on your chosen vacation rental.

The Legal Landscape

The popularity of Airbnb and similar platforms took a lot of cities and municipalities by complete surprise. Once investors realized how much money could be made, many of them made aggressive moves in America’s most sought-after vacation destinations. Unfortunately, the enormous success of vacation rentals has incentivized several different groups to take legal steps to curtail them.

Hotel owners see a direct threat to their profits, and many of them have lobbied aggressively to make sure that vacation rental owners are required to pay the same hotel taxes and carry the same liability insurance that they do. Homeowners, on the other hand, may not want to live next door to a vacation rental.

So, both these groups have taken strong steps to push legislation that limits the amount of days you can rent your short-term vacation rental out in a year. Many major metropolitan areas are also getting tremendous pressure from traditional renters to curtail or limit the number of vacation rentals because the rentals are eating into the inventory of available apartments.

A Better Way to Invest in Vacation Rentals

As you can see, vacation rentals can be profitable, but there is still no such thing as a free lunch. There are a lot of potential pitfalls that go along with being an owner or operator of a vacation rental. The good news is that you’ve got more than one option for profiting from vacation rentals. Instead of owning and operating your own vacation rental, you can invest in real estate platforms that specialize in vacation rentals.

Arrived Homes is a great example of investment platforms that allow you to crowdfund or invest in vacation rental portfolios. The big advantage of going this route is that you don’t have to worry about scouting properties, managing properties, or dealing with tenants. You can simply invest in the offerings on the platforms, and they will handle the hard stuff while paying you a nice dividend (in a perfect world at least).

The reality is, unless you have specific property management experience, a lot of patience and live within easy driving distance of your vacation rental, investing in vacation rentals through a platform might be the most efficient way to go. Yes, there is always a risk of loss, but at least you’ll be investing in properties that have undergone due diligence from an experienced group of investors who know how to make them profitable.