Real estate has become a staple investment strategy due to its financial benefits, with the residential rental property market gaining immense popularity. With the promise of passive positive cash flow, owning and operating rental property, such as single-family or multi-family condos, is the most common way to invest in real estate. Rental properties are typically classified as either short-term or long-term or are known as 'Airbnb' or permanent rentals. 


Short-term rental properties have exploded in popularity due to tax benefits and sites such as Airbnb and Vrbo, making renting and managing property more accessible. Vacation rentals are ideal for second homeowners who want the flexibility of using their property when it's not rented. In contrast, long-term rentals are suitable for investors who prefer the assurance of steady cash flow over an extended period and do not intend on using the property for personal use. 


Ready to start building your rental property portfolio? We've created a complete guide to get you started. 



Rental property benefits


Investing in a rental property comes with two main benefits: the home's equity and positive, and in some cases passive, cash flow. Real estate is a stable investment because the home's value will appreciate over time due to the demand for finite resources. As equity increases, investors can use the assets towards a mortgage, collateral for other investments, or to sell for a higher amount than the purchase price. Rental properties also have an ongoing return on investment which ensures a positive cash flow. Investors will collect rent monthly, which should be more than the maintenance cost of the property. 


Short-term and long-term rental properties come with associated risks. Investors must consider property management style, cash flow, property maintenance, and local laws before investing in any property type. 


Comparing rental property options



Vacation rentals

Permanent rentals

Income

Higher gross income potential


Investors can easily adjust the rent price to meet the current market rate, maximizing gross income. Depending on the location and market conditions, a short-term rental property may generate 2-3 times the monthly amount compared to a long-term rental.

Consistent cash flow


Rental income is consistent throughout the entire year when a tenant is on a 12-month lease and pays the rent timely. Knowing how much cash is coming in each month makes it easier to budget for maintenance and repairs and accurately forecast the potential return on investment.




Property maintenance

Easier maintenance


Short-term rentals are easier to maintain because of the limited time tenants stay in a property. Homes are thoroughly cleaned each time a tenant leaves and inspected for any needed maintenance issues before a new tenant arrives.

 Third party property management 


Professional property management fees for a long-term rental property generally range between 8%-10% of the rent price per month. On the other hand, short-term rental maintenance can be as much as 30% of the rent price due to the frequency of guests resulting in more work required. 


Operating costs

Higher initial operating costs


Property rented short-term typically needs to be fully furnished and well maintained and may need to be consistently stocked with personal items such as sheets, towels, toilet paper, and cooking supplies.


Tenants bear more responsibility


Renters on a long-term lease generally take care of essential items such as home cleaning, yard work, and paying their utilities. Long-term rentals also typically have less wear and tear because tenants tend to take better care of a property they think of as their home instead of a hotel room.


Local laws

Eligible tax deductions


Many vacation rental owners are entitled to certain tax breaks or even deductible property expenses because of the property's short-term use. Be sure to check your local authority's rules and regulations on this.

More lenient local laws


Many municipalities have stricter rules for short-term rentals than for property leased to a tenant for a long term. Depending on the city or the HOA, occupancy may be limited to a maximum period, and owners may be required to collect an occupancy tax for short-term rentals, similar to a hotel room tax.


Tenants

Cheaper to terminate contracts



Short-term leases are generally less expensive to terminate and have less impact on estimated rental income than long-term rentals. 


Tenant screening is crucial.


Because a long-term rental usually has a lease of 12 months, screening prospective tenants is critical. Even with the best tenant screening process, a landlord may rent to a tenant who constantly complains, pays the rent late, or damages the property. Evicting a tenant on a long-term lease can be time-consuming and expensive. 

Financing

Higher down payment


Lenders typically require a higher down payment on investment properties due to the additional risk associated with second-home ownership. Down payments and interest rates can be higher when lenders view short-term rentals as having potential cash flow fluctuations. However, this risk varies depending on location and associated market demand. 

More attractive interest rates


Rental property occupied by a tenant on a long-term lease may also be more accessible and affordable when an investor knows the cash flow stream. Real estate investors may receive more attractive interest rates and financing terms when a lender views a long-term rental as having less potential risk due to vacancy and higher repairs.




What to consider when investing in a rental property



Financing

Whether purchasing a rental property as a second home or purely an investment property, lenders will associate more risk with these purchases, given that homeowners tend to prioritize their primary home when financial times hit. Investors should expect to pay a higher down payment and interest rate for their rental property, with occupancy and dwelling type being factors affecting their initial investment costs. With traditional residential mortgages, you can sometimes put down as little as 3%. In contrast, lenders typically require 20% of the purchase price for single-family investment properties and more for multi-family dwellings. There are three types of occupancies related to mortgage lending: primary, second home, and investment. Lenders usually charge higher interest rates for second homes and investment properties due to the risk that borrowers can walk away from these types of properties, with higher rates for investment properties than for second homes. Classifying your investment property or Airbnb as a second home may be tempting. However, investors are advised to disclose their intended use of the property and consult their mortgage lender about local laws and regulations, as both options have varying tax deduction benefits and implications. As a part of upfront costs, investors should also consider the cost of furniture and amenities required for a short-term rental property. 



Tax benefit

Second home

Investment property

Expense write off

Generally not allowed

Can write off mortgage interest, maintenance, utility bills and depreciation

Mortgage interest

Deductible along with property taxes, and mortgage insurance

Deducted from rental income as part of expense write offs

Rental income

Not usually taxable if property is rented less than 14 days per year

Must be reported if property is rented more than 14 days per year

Source: valuepenguin.com



Location

Where you buy or build your investment property is arguably the most impactful factor to the return on investment. Your location will impact pivotal factors such as rental rates, tenant demand, and the type of rental property you can operate. To gain the best return, invest in an area with high demand in the rental market, rental income that supports the property's expenses, and in a stable or growing economy. Not all short-term rental regulations are made equal, and it's not legal to operate in specific areas; therefore, it's vital to research your desired area's laws and tax implications.


Forbes council member and Prop Tech CEO Johan Hajji recommends that first-time investors consider locations where demand from their ideal customer, whether a tourist, business traveler or long-term lease tenant, is high to maximize earning potential. Prime locations operate year-round rather than charge peak rates during specific seasons. Use Airbnb and similar hosting websites to scroll through the competition and evaluate what rates they charge, how often they host, and for how long while determining your ideal location. 


For investors with more liquidity, acquiring a high-end property that offers space, a central location, and a luxury experience appeals to a consumer market where guests are willing to pay more. These properties appeal to business travelers looking for the home-away-from-home experience and hold high positions in the industry where rent is a part of the budget. Additionally, there is a growing demand from the 'wealthy tourist' market, who are willing to pay more to enjoy a premium vacation experience. 


Local area factors to consider:

  • Walk-ability to entertainment, food, etc.

  • Occupancy rates

  • Current supply and demand in the area

  • Average revenue for rentals in the area

  • Crime rate


Return on Investment

Once you've found your ideal rental property, Whether an existing property or a new construction home, it's time to do the calculations to understand the estimated income the property will generate. Your estimated income should exceed all monthly expenses, which typically include mortgage payments, property management, repairs, taxes, and insurance.


A simple way to evaluate whether your property is worth the investment is to use the 1% rule. The 1% rule measures the price of the investment property against the gross income it will generate. For a potential investment to pass the 1% rule, its monthly rent must be equal to or no less than 1% of the purchase price. This rule is an excellent place to start when determining whether a property will meet your investment objectives. However, investors should consider other factors when deciding what to charge tenants and understand that rental prices are not static and should adjust based on relevant factors such as location and demand. 



Property management

Acquiring the right property is half the battle. Investors must determine how they intend to manage their property as it impacts varying aspects, from monthly expenses to tenant experience. For short-term rentals, using services such as Airbnb or Vrbo provides a trusted platform to find quality tenants and collect rent and additional fees for cleaning and maintenance, making property management simpler. Routine maintenance of short-term rentals is crucial to avoid emergency repairs or poor reviews, which can negatively impact consumer demand in such a competitive market. 

Hiring a third-party property management company is ideal for investors with many short-term rental properties or short-term rentals far from their primary residence. These companies will handle everything from repairs to rent collection with varying payment structures and fees. The fees can be a flat rate or a percentage of the rent ranging from 8% to 12%.



Conclusion

Rental properties continue to be the most popular means of investing in real estate, and with good reason. All investments are associated with risks that can be mitigated through proper guidance and planning. Investing in a rental property involves finding the right property within an area that has a stable or growing economy. Following this beginner's guide and consulting with a Welcome Advisor on ideal rental property locations is the first step to building a successful portfolio. 


Consult with a Welcome Advisor today. 







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