As vacation rentals rise in popularity, more people are starting to ask themselves, “are vacation rentals a good investment?”
Vacation rental properties can be a great investment depending on several factors that are unique to each buyer. According to a recent report by the National Association of Realtors, 30%of vacation property owners and 32 percent of investment property owners planned to rent their homes as short-term rentals in 2018. That’s a significant increase over the 2017 figures of 25% and 24%. And that’s not all — an additional 10% of vacation owners and 7% of investment owners will try renting their homes as short-term rentals this year.
But do they offer good rates of return? Are they smart investments for retirees? How do they impact your cash flow? That depends on many subjectives. To decide if one is right for you, consider these questions:
How much money can I make from a vacation rental?
The answer to that is as variable as homes themselves.
Crystal Stranger, CEO of Peacounts, owns 9 vacation rental homes. She urged prospective owners to analyze the markets where the might buy.
“It is very hard to project the income unless you really get to know the specific market,” said Stranger. “I do that by going and staying in other vacation homes and researching the market from the travelers’ side. Which properties are booked, how much availability is there in the area during prime times, holiday times, off-season times? You must get a feel for the market and that can take three to six months of times.”
That’s only part of the path to profitability, though.
“These can be very good financial investments, but you have to enjoy learning why people choose a vacation home over a hotel stay,” she added. “There are different sets of expectations for different sets of travelers – families, singles, business travelers. There’s a balance you must maintain to make sure the guests have what they need and are happy.”
And, clearly, you must have the cash flow to make changes and renovations to improve the property to meet guest demands.
Short-term vacation rental or long-term vacation rental?
The choice of short-term or long-term vacation rentals depends on many factors including home location, homeowners’ cash flow, retirement goals, loan obligations, and more.
But think of Stranger’s advice to analyze a market. A home in a college town might make a great long-term rental for visiting faculty while a beach location is likely a profitable short-term rental.
Of course, each has trade offs. High-end short-term rentals in seasonal locations such as the East Coast can rent for $10,000 a week during the prime season, but drop to $3,000 a week or lower during off-peak times, said Realtor James Nellis, CEO, The Nellis Group, Alexandria, Va.
“If it’s a $500,000 property, the owner is typically making their money back in three months, just because of the amounts they can charge during peak seasons,” he said. “The trade off is those properties go dormant for months, perhaps with the exception of New Year’s week. That’s a premium holiday time.”
Although long-term rentals promise more stable income, that’s not always a plus. If a major repair is needed, you can’t raise the rent until the lease expires.
But that doesn’t mean that you can charge exorbitant fees for short-term rentals.
“A fair rental price is mostly based on facts and circumstances,” said Timothy Reiter, CPA, MST Tax Manager, Nussbaum Yates Berg Klein & Wolpow (NYBKW), LLP, Melville, NY. “However, a rental price would not be considered fair if the amount charged to an unrelated person is substantially less than the rent charged for similar properties in your area. Similar depends on many factors, but some include the purpose it is used for, the size, the condition, and the location.”
How to pick a location that’s profitable for your vacation rental
This depends on how you define profitable, as we noted above.
You can make earn considerably more money from a beachfront location but the home will cost more to purchase and perhaps maintain. It might be more profitable to buy a less-expensive home a few blocks from the beach although it won’t command top rental prices. Research and analyze your market, as Stranger recommended.
Don’t forget to research local laws and regulations, too, added finance and tax expert Rob Stephens, co-founder and general manager of Avalara MyLodgeTax.
You may find movements afoot that greatly restrict what you can do with your home. said Stephens, a vacation rental home owner. He noted homeowners’ associations and condo boards might also negatively impact a property. Research and analyze all agencies and associations that may impact your home.
Tax implications of owning a rental home
Although Stephens and his wife are both tax experts, they found it challenging to determine the taxes that were owed on their vacation rental properties. That’s one reason they founded a business that allows vacation rental home owners to stay compliant and collect and pay the correct taxes to the correct parties.
Stranger noted that failure to pay the correct taxes is one of the most common pitfalls of vacation home rental owners who often don’t understand what defines a home as a business or a passive income property.
Also, many factors come into play to determine if a vacation rental home is defined as a true rental property, if the money collected is passive income, depreciation allowances, definitions of personal and business experience, and a web of deduction clauses and exceptions, said Reiter.
Those that want to use their vacation rental properties for themselves or their families face extra scrutiny, he said.
“When a taxpayer rents a residence that he also uses personally, the rental expenses relating to the residence may be limited depending on the number of days it is used for personal purposes,” he said. “The purpose of this is to prevent taxpayers with a residence that is used for both rental and personal purposes to defray the costs of home ownership with rental expenses.”
The vacation home rules apply when personal use of the residence exceeds the greater of 14 days or 10% of the days it is rented as long as it is rented for more than 14 days during the tax year, he said.
That’s especially important for those who think of vacation rental properties as opportunities for deductions.
“The greater the ratio of personal use days to days the property was rented, the less deductions a taxpayer will be able to deduct under the vacation home rules,” he said. “Days where the residence isn’t used for rental or personal purposes do not factor into the ratio. For example, a summer home that is used as a rental and for personal use for June, July, and August and is vacant for the rest of the months would have a denominator of 92 when figuring the ratio; not 365 or 366.”
The good news for many – yes you can rent your home to a family member as long as it is not their main home, don’t have a financial stake in the rental property and pay a fair rental price.
“If the vacation home rules apply, all rental income associated with the property is included in income,” he said. “This is the easy part.”
There are plenty of not so easy parts including how deductions are divided, what financial information impacts which schedule, income that is not fully deductible, ineligible deductions, and more.
As with most other topics, this depends on many subjective personal and business factors. It is also an important factor to decide before you invest in a vacation rental property.
Certainly, your cash flow is a factor. Some vacation home owners pay between 25 and 50 percent of their rental income to the property manager. Most consider it money well spent because professional management boosts the likelihood of repeat business and excellent guest reviews. It also frees the owner from time-consuming tasks including property maintenance and guest relations.
But all property management companies are not the same. Ask about fees and contracts but interview the managers to determine how well they know the area, how they will market the property, how often they will update you on the property and more.
So is a vacation rental property a good investment for you?
Only you can decide, but heed this advice.
“All investments come down to the numbers,” said Nellis. “I used to have a financial advisor who compared life to a baseball diamond. The closer you are to first and second base, the more risks you can take. One you are between third and home base, you should be more conservative.”