They can be, but thoroughly researching and understanding their financial, legal, and operational aspects is essential to avoiding loss.

Are you considering investing in vacation rental properties, or are you a lender exploring options to expand a program for short-term rentals?

With the travel industry on the rebound, now might be the perfect time to explore this sector. Buying a vacation rental property has become increasingly popular, and in today’s current market, you can find numerous success stories. But, as with all things, sometimes what makes these properties potentially dangerous to an investor’s portfolio isn’t always talked about.

Let’s delve into the pros and cons of vacation rental property investing and lending.

Understanding the Vacation Rental Market

The vacation rental market has experienced significant growth during the past few years. According to data from AllTheRooms.com, there are nearly 1 million properties listed as short-term rentals on places like Airbnb and VRBO, which is 65% higher than the number of homes for sale according to Realtor.com.

Some of this growth is due to travelers choosing vacation rentals over traditional hotels, seeking unique experiences and more space for their getaways. Additionally, the rise of online booking platforms like Airbnb and Vrbo has also made it easier for property owners to connect with a vast audience of potential guests, increasing the opportunity to keep their properties rented.

As a lender, one of the best ways to help mitigate your risk is to understand the property market. Easy Street Capital has very strict guidance around what experience an investor has in a particular market. Robin Simon, one of their partners, noted: “We give particular weight in our underwriting evaluation for investors who have more than one short-term rental in a given market and can demonstrate performance and success with that property.” Simon noted they look for a demonstration of the borrower’s property performance by requiring the property to be listed with at least one national listing site like Vrbo or AirBnb and evidence of at least one completed booking by way of verifiable income through a third-party report or bank statements. This type of borrower-qualifying item can help mitigate the risk for a lender who may not intimately know the buying market.

Identifying Profitable Locations

One of the keys to success in vacation rental investing is choosing the right location. Although there is no perfect science as to what may work for one investor versus another, here are opportunities to consider:

Tourist Hot Spots. Areas like Myrtle Beach, South Carolina, or Orlando, Florida, draw a huge influx of tourists every year. With consumers wanting different experiences for their travel these days, a short-term rental property will be a better investment for both the borrower and the lender financing that property than a more obscure location will.

Areas with a Strong Local Economy. Places that generate business travel and conferences, or even areas attracting large industry, are prime markets for short-term rental properties—places like Austin, Texas, where Tesla, Meta, and USAA have large campuses, for example.

Other Markets. An investor and/or lender could even capitalize on more obscure markets. Take Floyd, Virginia, for example. Although Floyd itself only has a population of about 435 people (with a very quaint walkable downtown, including an awesome open air farmers market), it hosts a litany of events and festivals in the area far past what the local area hotels could support.

But buyer and lender beware! Sometimes even in areas with great economic growth, an oversaturation can cause diminished returns. For example, in Phoenix, Arizona, Airbnb owners have seen their revenues plummet by more than 50% between early 2022 and May 2023, likely due to the fact that the supply of short-term rental properties has nearly doubled in the same time frame.

Analyzing Rental Trends and Seasonal Demands

To make the most of your vacation rental investment, conduct thorough market research. Tools like AllTheRoom.Com and AirDNA are great resources for both investors and lenders. Additionally, use technology to help you understand the property revenue.

In a recent call, Simon noted: “Lenders must consider utilizing things like the AirDNA Rentalizer qualification tool.” In fact, Easy Street has built into their website a STR Revenue calculator that can provide an estimate of expected revenue and ADR for any eligible address in the United States.

Using these tools to analyze rental trends and seasonal demands can help a borrower optimize a property’s occupancy rate and pricing as well as help lenders in understanding a truer sense of debt coverage and risk. As noted, the property market is a key driver in analyzing trends or seasonal demands. As a lender, you may understand that a property in Breckinridge, Colorado, will drive a potentially higher nightly rent in the winter months for skiers than it will in the summer months and, therefore, get comfortable with an average rental rate across seasons.

Assessing Financial Viability

Lending or investing in vacation rental properties requires careful financial analysis. You should consider not only the purchase price and renovation costs but also ongoing expenses such as property management, utilities, and maintenance, much as you would with any rental property investment. However, with short-term rentals, your expenses can be significantly compounded for things like wear and tear, extra cleaning costs, and marketing to keep the property occupied. These extra costs will impact the financial viability of your asset and can vary widely depending on the property and its local short-term rental market.

Perhaps the most significant difference in short-term rentals versus long-term strategies is the potential for regulatory restrictions. Local municipalities, state regulatory bodies, and others (e.g., HOAs) can all have a dramatic impact on the viability of a short-term rental performing. Lenders should do their due diligence in reviewing any HOA documents or local/state laws for regulations that can impact a short-term rental.

Of course, one of the ways to mitigate risk for a short-term property is to qualify it as a long-term rental using the standard market rental analysis. Using this qualifying strategy, a lender knows that even if regulations changed to not allow short-term rentals, the payment would be covered through a long-term lease. Otherwise, the only real strategy is to sell the property to minimize loss for the borrower and lender.

Managing Risks

As with any investment, there are risks associated with vacation rental properties. Market fluctuations, regulatory changes, and unforeseen events can impact your returns. However, preparedness and proactive management can mitigate these risks.

The viability of short-term rentals can vary significantly depending on various factors, such as location, local regulations, tourism trends, and economic conditions. What might be considered the “best” and “worst” markets for short-term rentals can change over time. Although things like strong economies, tourism, and other previously noted factors can be positive for a short-term rental, there are also things that can inhibit an investment and lenders should scrutinize. Regulatory changes, economic shifts, or even negative rental ratings are all examples of things that pose a risk.

Regulations around short-term rentals can vary significantly depending on the location and jurisdiction. They can encompass registration, permits, duration limits, host presence, safety requirements, and zoning restrictions. It’s important for hosts and guests to be aware of and comply with these regulations to avoid legal issues and ensure a positive experience for all parties involved. Keep in mind that regulations can change over time, so it’s advisable to check with local authorities for the most up-to-date information.

Airbnb laws in the U.S. can vary significantly by city, county, and state due to the different regulations and zoning laws that govern short-term rentals. These regulations can impact aspects such as the legality of hosting, required permits, taxes, safety standards, and more. Here are a few examples of Airbnb laws in different U.S. cities as of fall 2021:

New York City, New York. New York City has some of the most stringent regulations on short-term rentals. It’s generally illegal to rent out an entire apartment for fewer than 30 days if the host is not present. However, renting a room within your home while you’re present is usually allowed.

San Francisco, California. San Francisco requires hosts to register with the city and obtain a business registration certificate. Additionally, hosts can only rent out their primary residence for a maximum of 90 days a year if they’re not present, and there are various restrictions on short-term rentals in certain zones.

Los Angeles, California. In Los Angeles, hosts must register with the city, and short-term rentals of an entire unit are generally limited to 120 days per year when the host is not present. Hosts are also required to collect and remit occupancy taxes.

New Orleans, Louisiana. New Orleans has a unique system that requires hosts to obtain both a short-term rental permit and a homestead exemption. There are restrictions on the number of permits issued in certain areas to maintain the character of residential neighborhoods.

Chicago, Illinois. Chicago hosts are required to obtain a short-term residential rental license. If the rental is for the entire unit, the host must also include specific information on the listing, such as the license number and the maximum number of guests allowed.

Austin, Texas. In Austin, hosts must obtain a short-term rental license and display it in their listing. Short-term rentals are subject to certain occupancy limits and noise regulations.

Nashville, Tennessee. Nashville imposes restrictions on non-owner-occupied short-term rentals, particularly in certain residential zones. Hosts are required to obtain a permit and adhere to regulations related to maximum occupancy, advertising, and safety.

Miami Beach, Florida. Miami Beach has strict regulations on short-term rentals, including requirements for hosts to obtain a business license and adhere to zoning laws. Short-term rentals in certain areas are prohibited.

It’s important to note that these examples might have changed, and regulations can vary within cities themselves. Always refer to the most current and local regulations to ensure compliance with Airbnb laws in your specific area.

Unfortunately, there is no all-inclusive resource for lenders to know state-to-state or local laws. However, a good internet search will usually return who the local governing authority is for the property. From there, standard due diligence practices of checking the authority site for details or even calling them will usually provide intel on what the current regulations or requirements may be. As a lender, it’s also important to have a line of sight to what renters are saying about the properties. Going through the posted reviews can give you good insight if the property owner has some type of egregious renting practice that could impact the revenue of the property.

Before jumping into short-term rentals, thoroughly researching and understanding their financial, legal, and operational aspects is essential to avoiding loss. Although lenders like Simon remain bullish on the short-term market, it isn’t without a measured approach. As with all things mortgage these days, it’s not for the faint of heart.