How should you compare long vs short-term rentals now

It’s time to consider investing in rental property. The stock market has taken a major hit and yet, housing prices are somewhat stable. Rents have been going up and they continue to increase. This is good news for long-term rental property. Short-term rentals are viable as well, another option for many investors. It’s all about chasing the elusive cash flow in this current economy. People want some stability in their financial lives and acquiring investment property is one way to accomplish that goal.

This article will get into some detail about the differences between long-term rentals and properties rented on a short-term basis.

Long-term Rentals – Definition

Single-family or multi-family homes are rented for 30 days or longer on month-to-month leases or an annual lease basis. Generally, properties of over five units are considered commercial properties and are placed in areas zoned for that use. The definition here is primarily for residential properties of four units or less located in residential zones either single or multi-family.

Zoning rules often preclude a property manager from renting a property in a residential zone for less than 30 days. Long-term tenants tend to stay for years and leases are generally for 12 months or longer.

Lease rates are usually stable meaning that the rate is set on a monthly rent rather than a nightly basis. Most states regulate long-term rentals and local governments have their regulations as well. The most common tenant will hold a one-year lease at the same amount per month for the entire term of the lease. The rental agreement is often called a lease agreement even when tenants are permitted to stay on a month-to-month basis. These properties are rarely furnished. Tenants must bring their furnishings.

Short-term Rentals – Definition

Short-term vacation rentals are usually rented based on nightly rates for less than 30 days. Rates vary with higher rates at the peak season. Long-term vacation rental properties are still in this category and are often called mid-term rentals. These properties are almost always furnished. The property management company usually regulates the calendar and often uses third-party companies such as Airbnb and VRBO to locate guests.

Guests rent short-term properties. Long-term properties are occupied by tenants. Zoning rules (local laws) will permit people to stay for less than 30 days often with a list of rules. Property managers do not involve property owners in day-to-day issues

Consider taking a course offered by KEYLADDER on investing in residential rental real estate or How to invest in vacation rental property for more in-depth knowledge about both investment opportunities.

How should you compare long vs short-term rentals now?

Both methods of residential rental investment property can be profitable. The calculator provided below will permit you to determine which direction to take for a selected property. Enter the monthly income generated for a long-term rental property and the expected rental income from your Airbnb rentals (short-term rental). Because short-term rentals generate monthly income which varies from month to month, using the average monthly rate for the year.

Enter the expenses you anticipate paying for each type of property every month. Enter the property management fee as a percentage. You will not be entering property taxes or insurance costs nor will you enter principal or interest. The object of using the form is to determine your net operating income. The mortgage and other costs apply to both properties. This form is not designed to produce a return on investment calculation, I will get to that later in the article.

Long Term Rentals

The steps involved with setting up a property for a long-term rental include the following:

1. Acquire the property in an area where there are existing rentals and there are no permitting issues
2. Update the property if possible. Repair everything that is broken. Replace worn materials such as flooring.
3. Curb appeal is important to attract the best renters. If it looks clean and nice, hopefully, your renter will want to keep it that way
4. Consider interviewing property management companies. A property manager will cost you but if you want to scale up it’s a good investment strategy
5. Avoid bad tenants by running background checks and requiring a security deposit. Tenant screening is very important
6. Long-term renters can provide a steady income which may be a better option than month-to-month renters. A year-long lease will reduce your costs and tenant turnover
7. Obtain a long-term contract for your selected tenant to sign.
8. Select new tenants and explain the house rules.
9. Video the property and give the new tenants a copy. Explain that the property damage they cause will cost them. Explain that you will perform regular maintenance and that you want them to report any issues to you immediately.

Some benefits of long-term rentals

1. Tenants will stay for a longer period, perhaps years if you maintain the property
2. Long-term renting can provide a stable income source
3. Financial institutions will give you credit for about 75% of the monthly income derived from the property with long-term renters
4. Income comes every month at the same rate so you can budget on repairs etc. as a portion of the income
5. The consistent income, the same amount every month on or about the first day of every month is reassuring.
6. Residential rentals can provide higher income over the years as you can raise the rate each year to keep up with the market.
7. Long-term rental properties can be located nearly anywhere as most communities do not restrict them. Many people rent their former homes.
8. Rental owners can have the tenants take care of the grounds. Tenants can mow the grass and tend to the landscaping saving owners money.
9. There are fewer rental expenses and save repairs which good tenants will point out and you can do them before the issue becomes worse.
10. There is high demand for long-term rentals in many markets. A housing shortage exists in several markets.
11. Good tenants require little management time. Some tenants can do minor repairs with your permission and you can give a rental concession.
12. Passive income tax benefits can accrue. Repair expenses are a write-off. Depreciation is a benefit.

Maintaining your property is the key to profit

I know people who have rented the same property for more than 10 years. During that time most of the owners maintained the property. In other cases the owners let the property fall into decay factoring in that they can still sell it for a profit since they did not expend any money to repair it.

Owners put these neglected properties on the market and initially ask for far more than they are worth. The final selling price will reflect the condition of the property.

Good tenants tell you when something is wrong e.g. a leaking sink. You call a plumber and have it fixed before it becomes a more serious problem. Many good tenants will fix small things and not cause further damage.

Regardless, you must include a regular inspection of the property. It takes less time to inspect and repair than to deal with emergencies.

Back to the property manager. I strongly recommend the use of a professional property manager for a residential rental property. Real estate investors who wish to buy more properties must consider the effort to manage their properties and how that affects their ability to scale. The best way for property investors to continue growing their portfolios is to have others do the legwork of management.

Not all renters are good tenants. Some require lots of work and evictions. This work takes a specialist and that is where the property manager comes in. Read the KEYLADDER.COM blog site for more information on property management.

Every investment has its cons or reasons to consider another investment. This is where we will talk about the potentially negative side of long-term rentals:

1. Bad tenants can cost a property owner big dollars if they don’t pay rent on time or at all
2. Property damage caused by a bad tenant can get very expensive
3. Bad tenants can introduce crime to the area, the police can call you at midnight
4. Bad tenants will hurt neighbors who may call code enforcement or the fire department
5. Some tenants will sublet without telling you
6. When you have a no-pet policy, a tenant may decide that does not apply to them
7. No-smoking policies may be ignored
8. The government may decide you can’t evict a tenant for non-payment during the next COVID event or another event
9. You can be sued by a protected class individual for a fake violation of one of the many laws that regulate long-term rentals
10. You could face jail time if you permit a property to decay and it presents a danger to your tenants
11. Major cities have very restrictive rules even rent control
12. If you have to evict it may take time without rental income
13. Time to repair a property is not only costly but you lose rent during the process

The above are all part of being a residential rental property owner. You can mitigate many of the negatives or cons above by paying attention to the items listed in the previous section. A good property manager can significantly reduce risk and cost. There are tens of thousands of investors who have become successful including long-term rentals as part of their rental strategies.

Short-Term Rentals

Real estate investments can include short-term rentals as part of their overall investment strategy. Long-term lets are great and are essentially the foundation of residential rental investment strategies, adding short-term to the portfolio can be a good idea. Vacation rental properties are often rented when the owners are not in residence. This helps to cover some costs.

For this discussion, I will talk about a short-term property that is purchased specifically to earn income. This type of rental generates a higher nightly rate than a long-term rental and is the primary reason why a short-term rental can earn extra income that is not available to long-term properties.

The biggest benefits (pros) of owning short-term rentals are as follows:

1. Usually higher revenue with short-term rentals vs long-term rentals. This translates into higher ROI and COC.
2. Can be bought as a second home (at least the first one) and receive a favorable interest rate
3. Short-term rental properties are in demand. It has taken years for the bulk of the population to catch on to their efficiencies, low cost per person, etc. and the market is here.
4. The investment real estate market is now comprised not of just long-term rentals but vacation property that has been converted into short-term rentals
5. There is higher demand in some areas for what guests call vacation rentals than there is for some hotels
6. Higher prices are charged during the summer season for beach area property and higher rates are charged for mountain property in the ski season. The high season brings in the most income.
7. There are tax breaks available for short-term rentals similar to long-term rentals
8. Generally, there is less wear on a vacation rental because many of them are only rented about 35% of the time. The occupancy rate will vary with how long the property has been available to rent.
9. Evictions are extremely rare, guests come and go as required with their agreements
10. Property managers will manage the calendar, cleaning, and maintenance for an absentee investor
11. Owners will have the personal use of their properties located in popular vacation destination locations. All they need to do is pay for cleaning. Their stay is effectively a tax write off
12. Some guests will return year after year increasing the occupancy rate with little effort.
13. Some owners can convert their primary residence to a vacation rental rather than sell it. This is a low-cost method since it is already fully furnished. Financing is in place and there are no purchase costs. The income can be substantial with this arrangement.

Benefits that guests receive for staying at a short-term rental

As I have mentioned, in recent years people have discovered the great benefits of staying at a vacation rental vs a hotel. Here are some of the reasons why a vacation rental appeals to people particularly families and those who want a longer stay:

1. The cost per person is lower than a hotel. 10 persons staying at a place charging $300 per night = $30 per person. If two persons in a hotel room charging $150 per night the savings are $90 per night.
2. Pets are often not accepted at hotels. Pet owners can find a vacation rental that accepts pets for a modest upcharge
3. Yards for children to play and dogs to roam free
4. Amenities such as fire pits, horseshoe pits, bbq, and social areas on the property encourage outdoor activities
5. Families can stay together. This is very important for many. No crowded rooms with luggage scattered around.
6. Cooking in the kitchen can save money over restaurants. Even the refrigerator is beneficial.
7. Liquor allowed in most vacation rentals
8. Multiple bathrooms. Better than four people staying in one hotel room with one bathroom
9. Coming and going without walking through a lobby or parking lot. Generally safer.
10. Feeling more at home staying at a property that is set up for home-style comfort.
11. Pick your location, want to stay at the beach or in the mountains? More options. Hotels are generally in business districts, vacation rentals are in housing areas.

As you can see, there are many reasons why people would want to stay at your vacation rental. The types of rentals vary from single-family homes to condos, townhomes even mobile homes. The most important thing about selecting your short-term rental is location. The property must be where people go for their vacation. There is an exception to this statement. Some short-term and mid-term rentals cater to visiting nurses and professionals or the military.

These properties need to be near where the guest will be working. If the house is near the beach it will attract a visiting nurse who has to drive 20 minutes to the hospital because they like the location.

On the other hand, a property located 25 miles from the beach near a business district or hospital, or military base would attract those who are not interested in being a tourist. They want something close to avoid traffic and just want to drive home after work and relax. The point about the location is that it must be in a place where your target market wants to be.

Here come the Cons of short-term rentals

You have already read the list above of the cons or negatives of long-term rentals. This is our list of cons for short-term rentals:

1. Location dependent. Long-term rentals are not so dependent on location. Short-term rentals will make money based on where they are relative to the target market.
2. Guests can cause damage. Usually, the damage is the breakage of small things e.g. window blinds but it can be more substantial. One guest ruined a stove top with a fire.
3. Weather events can keep people away. A snowstorm or hurricane can prevent guests from arriving or even booking.
4. The cleaning crew does a bad job and guests are upset, they give you a 3 rating. This is very bad, ratings are very important
5. Competition can lower their prices forcing you to do the same. Remember many short-term rental owners are not professionals, they do not understand pricing and marketing
6. Furnishings get worn. Couches get stained, carpets get worn. Appliances break down
7. Macro market influences. Guests come from all over, if there are major issues in an area e.g. a flood it can use guests to cancel and it may be too late to book
8. The municipal government may create new rules. You are renting to 10 guests, the new rules reduce it to 6. This change can affect your income.
9. Neighbors can become anxious because of bad guests. They call code enforcement and your permit is revoked.
10. The overall market slows down such as the beginning of COVID. After COVID the best rental season ever. Owners need to be able to cover short-term losses
11. Short-term rental requires an investment in furniture and furnishings. This can add $10,000 to $30,000 to the cost of acquisition.
12. Added cost to set up the short-term rental is decorating and placement. If you do the work yourself you can save the professional fee but there is still a cost for the materials
13. The time it may take to set up the property can be a few days to three weeks. It takes time to have contractors paint, lay flooring, order furniture etc. Zero income until rented.
14. Takes time to build up to maximum income.

You can mitigate the cons of short-term rentals

As with long-term rentals, you can mitigate risk in some big ways. ChristiesGulfBeachRentals.Com offers vacation travel insurance at no additional cost to your book on their website. This is a very important point. Offering this perk makes sure that cancelations due to covered incidents such as delayed planes, hurricanes, etc. will cover their investment and you retain their fees. This is just one example of what you can do to prevent losses.

Create rules, and make sure guests know the rules and the fact that they will pay for damages. Sell guests damage insurance which Christie’s does for a modest fixed fee. Parents with kids should buy the policy and those with pets as well. This protects the guests and the owners. Hiring a good property management company can make owning a short-term rental property a great passive investment. The managers do all of the work and deposit the income into your account every month.

Generally, short-term rentals will earn more income after expenses than long-term rentals. This means that over time as the third-party sites see your property rented more frequently with high ratings, more and more people will want to stay there. While long-term renters pay the first month they arrive, it may take months to ramp up income.

Income comparison of short-term vs long-term rentals

As an example of the income differences between both types of rentals, I am providing the following example from one of my own rental properties.

A two-unit property is within walking distance of the beach. This was originally a house with two bedrooms and one bathroom. The second living unit was an addition years later. Each has its own character with separate entrances. One wall attaches both properties making it an official duplex although neither side looks like the other.

The original intent was to rent both units on long-term leases. Tenants in Unit A, the larger unit pay a $1,000 per month lease payment. The back unit which is a very large one-bedroom, one-bath with a living room and kitchen/dining room rents for $875 per month. The rental market has moved up recently so those properties would rent for $1,100 and $1,000 per month.

Earlier in the year unit B, the smaller unit, was converted into a short-term rental. It’s generating about $1,900 in average monthly income. The smaller unit should generate more than $2,200 per month during the second year. The electric bill averages about $120 per month and the internet charge is $60 per month. Water was already part of the cost along with landscaping.

The conversion produced greater income for the short-term side

The NOI is $1,720 which is $845 per month (after management fees) 44% greater than the long-term rate. The change is more profitable from the first month and will become a greater contributor as the property gains a reputation.

The front unit remains a long-term rental for the present. The larger unit will become a vacation rental next year. Based upon experience with 2×2 properties in the area, the income generated in the first year should be in the area of $2,600 per month on average. This is of course income after management fees.

Based on the forecast, the property should generate an NOI of about $2,470 + $1,720 = $4,190 per month. An increase of $2,315 per month over long-term rates. Not all properties can earn more NOI with short-term rentals vs long-term rentals. The size of property, rates in the area, length of time on the market and other factors may lean in favor of one type of rental or the other.

Your Conclusions

Have you decided which type of residential rental property is best for you? Do you want regular income or big dollars in season and smaller income during the off-season? Before you can make the final determination you need to run the analysis on a single property that can be either. Check out this article about current mortgage rates and housing prices

KEYLADDER offers two courses to help you understand how to invest in residential rental property. The first course is our flagship course which covers all types of rentals and includes tools for evaluation. “Investing in residential rental property” includes everything you need to become a successful investor.

The next course is a full course on how to invest in vacation rentals (short-term). You may want to consider enrolling in both courses. Click the button below which will take you to our school. Take one or both of the FREE mini-courses by clicking the button below.

Please read some of our other blog articles intended to supplement The KEYLADDER school. Listen to our podcast as well.

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