Vacation homes and other short-term rentals are becoming increasingly popular as investors realize the opportunity these assets represent in terms of high returns. However, some of the requirements for high returns are somewhat dynamic in nature. For example, when you choose where to invest in Airbnb rentals, you should go for locations with high demand from tourists and business travelers and relatively low property prices. This formula will nearly always result in high occupancy rates, high rental incomes, and high returns on investment, assuming you also choose a market where short-term rentals are legal and regulatory restrictions are few.
However, no matter how carefully and diligently you research the real estate market and choose your location, you are not insured against a sudden change in the legal environment with respect to Airbnb rentals. As the vacation rental homes industry is growing, it faces strong opposition from the hotel lobby (because of competition) as well as residents (who are afraid for the safety and tranquility of their neighborhood). This means that places where Airbnb rentals were fully legal yesterday might already consider them illegal today.
Say you buy a short-term rental property in the perfect market, but the situation changes a few months or years in. What should you do? If you did the right kind of market research before making the purchase, you should be able to easily “flip” your rental strategy by Daniela Andreevska and then, if it becomes an option, flip it back again later.
“Flipping” Strategies is Not Like Flipping Properties
When it comes to Airbnb and other short-term rental investments, your best bet is to invest in a property in a location which will make a good traditional (longterm) rental too. How do you recognize such properties and markets? It is best to rely on real estate data and analysis to make an investment that will work on short-term as well as long-term basis. There are two indicators that will help you identify deals where traditional rental strategy is also an option:
No. 1 Rental Demand / Price to Rent Ratio
There are many ways to measure rental demand, and you should definitely keep your eyes open for such factors as a strong economy, a growing labor market, new businesses opening there, etc. However, you should also look at the price-to-rent ratio, which is a simple real estate metric which indicates whether it is better to rent a property or buy a home in a particular market. For example, if the home is worth $200,000 and rents for $1,000 a month, then this ratio is 16.67 (200,000/(12×1,000)). Housing markets with a price-to-rent ratio of 21 and above will generally enjoy high demand for traditional rentals. If the ratio indicates it is better to rent, you can probably expect a greater demand for your rental if you flip to long-term.
Example: Palm Springs, California, is one of the top locations for investing in Airbnb rentals this summer. According to data from Mashvisor, an advanced real estate data analytics company, the average cap rate at the city level is 4.6 percent. This is much more than you can expect in most US real estate markets at present. This makes Palm Springs a great place to invest in a vacation rental. However, take note: In early June of this year, local voters rejected a measure which would have virtually banned shortterm rentals in Palm Springs. Vacation rental owners can’t be sure that such a measure won’t be proposed once again. If it were proposed and passed, the good news is that the price-to-rent ratio in Palm Springs is 32, which gives investors the confidence that they will be able to flip relatively smoothly to a traditional rental strategy if the need arises in the future.
No. 2 Cap Rate
A key metric in regard to ROI is the capitalization rate, or CAP rate for short, which shows the ratio of the net operating income (NOI) from your rental property over its current market value. If the CAP rate is relatively sound for both long- and short-term rentals, this is a good sign for your ability to flip your strategy.
Example: Baltimore, Maryland, has a city-level CAP rate of 1.9 percent for Airbnb rentals and 3.0 percent for traditional rentals. While these numbers might not sound too tempting, there are many localized areas of Baltimore that offer much more attractive metrics, which is why this is a good scenario for our purposes. For example, the CAP rate for short-term and long-term rental properties in the Heritage Crossing neighborhood (a particularly attractive area) goes up to 7.9 percent and 6.6 percent, respectively, and those are both relatively attractive values for this metric.
Pro Tip: Don’t rely solely on citywide numbers. Pay close attention to neighborhood metrics and data as well. Different areas within the same city may yield very different ROI.
Learn more about AirBnb’s in this related article: 3 Signs an AirBnb Rental Could be Right for Your Market.