How to Evaluate Vacation Rental Properties

How to Evaluate Vacation Rental Properties

Do you want to earn a good source of income? Or are you just enthusiastic about investing in a vacation rental property? Do take note, vacation rental properties are a lucrative rental business although you should take into consideration and carry out research before investing in a vacation rental property.

Let’s take a deep dive into whether investing in a vacation rental property is the right step for you as a long-term investment. With that said, this article will guide you through the following:

  • Is owning a vacation rental a good investment?
  • What are the pros and cons of the vacation rental?
  • What are the steps to investing in vacation rental properties?
  • How to estimate vacation rental potential?

Is Owning A Vacation Rental A Good Investment?

Owning a vacation rental boils down to investors who do follow the suitable steps to buying a vacation rental property are more likely to gain the many benefits that come along with it such as tax write-offs and incentives, a personal getaway, and a future retirement home. The apparent biggest benefit of it all is the increased cash flow especially when your property is in high demand. With that said, a great way of generating income from a vacation rental is through vacation rental platforms such as Airbnb, VRBO, and Booking.com.

However, take into account that investing in a vacation rental property does come with exceptional challenges. Therefore, with the help of proper planning and appropriate market research, a vacation rental investment can be a lucrative endeavor.

What Are The Pros and Cons of Vacation Rental Investment?

Before diving into buying a vacation rental, note that it has its benefits and drawbacks discussed below:

Pros

More Income

One of the attractive and obvious benefits of vacation rental investments is having to earn an extra income. More importantly, your vacation rental investment’s earning depends on your rental’s location, whether it is on a tourist hotspot or a populated area as well as other factors like its amenities and target guest. Note that rates for your vacation rental can be adjusted accordingly and have higher earnings during the holiday season and on weekends.

Having your own Getaway

Another benefit of investing in vacation rental properties is having your own vacation home is having the convenience and pleasurably taking advantage of at any time by simply using your vacation home for special events such as birthdays, family get-togethers, or even for personal getaways.

Tax Benefits

Without a doubt, renting your vacation rental for two weeks per year is considered a business. Hence, this is extremely useful for tax purposes as it allows you to write off any expenses related to your vacation rental as a tax-exempt business expense. These write-offs include but are not limited to property management fees, mortgage interest, insurance premiums, cleaning, and lastly supplies.

Fixed Investments & Retirement Home

Keep in mind, buying a vacation rental investment is a great and ideal future investment as it will grow in value over time. And more importantly, since it is a valuable and reliable asset, at a later stage, you have the option to sell and cash out on your investment, ensuring for future expenses or may be kept as a future retirement home.

Cons

Property Management

In comparison to traditional renting and for those hoping to rent a vacation rental, take note that it requires a lot more property management such as overseeing the cleaning and maintenance, responding to guests’ messages, organizing check-ins and checkouts, listing properties to various platforms, and so much more. And having to manage your own especially if you have several properties can be overwhelming and time-consuming.

Finding Guests

Take note, finding guests can be difficult and daunting which, therefore, it is important to market your vacation rentals through social media platforms such as Facebook, Instagram, LinkedIn, and Pinterest. Doing so will help attract potential bookers which possibly convert into a reservation.

Furthermore, to improve your SEO and listing rankings, take note to update your listing from time to time.

Restrictions & Regulations

Depending on the location of your vacation rental, take heed that some cities will have a number of restrictions and regulations related to short-term rentals, which, therefore, is important to learn more on what are the local laws and regulations required before investing in a vacation rental property.

Recurring Cost and Payments

Without proper management, especially if you do not employ a management company, recurring costs may affect your monthly revenue that may not be able to cover expenses, particularly during the low season. Recurring costs include listing fees, property management fees, cleaning and maintenance costs, and restocking rental supplies.

Inconsistent Income

Take note, it will be unlikely for your vacation rental to earn the same amount of income all year round. Due to having a high and a low season, expect that vacation rentals generate inconsistent earnings. Therefore, it is important to be aware of seasonality for you to be able to maximize your income during the peak season.

What Are The Steps To Investing In Vacation Rental Properties?

Location

The golden rule to investing in real estate is the location and it’s no surprise to anyone who is learning that it is the first and crucial step to investing in real estate. And honestly, it is more important than anything else.

Whether you choose to invest in vacation rentals that have a high occupancy rate, do consider specific areas that have potential that will help maximize profits such as city centers, tourist hotspots, and business districts. Though take note, it is more likely to be expensive and may come with several short-term rental restrictions and regulations applied.

Market Analysis

To help you choose the ideal and type of property in the areas to invest in, experts recommend doing a deeper market analysis allowing you to compare and assess what other real estate properties perform in the local market. Doing so will likely help you understand which is most likely to give you a return of investment.

With that said, free-listings in Airbnb are a good starting point to look for your initial data helping you scale expected rental income as well as articulate income expectations for your vacation rental later on.

Furthermore, areas that offer momentous attractions in both summer and winter for potential visitors are good examples of what factors a real estate investment should have. More importantly, utilize smart analytical tools that are on the market such as AirDNA and Mashvisor to help you make shrewd decisions in making an ideal vacation rental investment.

Vacation Rentals Vs. Traditional Rentals

It is important to understand the unique characteristics of traditional rentals and vacation rentals. Note that a vacation rental is seasonal and may sometimes affect your bookings. With that said, investors should consider vacation rental properties that offer both summer and winter attractions to help maximize bookings all year round. Furthermore, investors need to recognize and prepare vacation rentals catering to the different seasons of the year.

More importantly, unlike traditional rentals, investors also need to understand that there are other expenses tied to vacation rentals such as regular cleaning and maintenance, insurance, etc.

Expected Expenses Vs. Expected Income

Once you have found a suitable property, consider thinking about your expected net income as well as your gross rental yield. Gross rental yield is the annual rent expected which is divided by the overall property costs. And with that amount, times this number by 100. The property cost should include the purchase price, furnishing, and closing expenses. With that said, take into account expenses for utilities such as maintenance and cleaning, you need to include as well as other fees such as homeowner’s insurance, property insurance, and property management fees. Furthermore, although it is possible to manage the property or several properties on your own, it’s recommended to use a professional management company like Hostaway to help upkeep, manage, ensure repeat bookings and positive guest reviews.

Advertising Your Vacation Rental

Once you have established your vacation rental investment, it is important to list and market your properties on platforms such as Airbnb, Booking.com, VRBO, etc. Doing so will help hosts to potentially generate more bookings by making it more visible and accessible to potential bookers.
As a matter of fact, some property owners list properties on social media platforms or for a nominal fee to ensure potential bookers are well-screened and have secured transactions.

Deciding On How To Finance A Vacation Rental Property

There are several options ranging from short-term to long-term loans for investors in financing their vacation rental investment as mentioned below:

Conforming Loan

This is a more well-known option for investors. The required qualifications are a credit score of 680+ with a down payment of around 20%. Apart from that, compared with other traditional loans, this option is more flexible.

Portfolio Loan

If you have more than one property, this option is more recommended for investors and the qualifications are more flexible in comparison to others.

Multifamily Loan

If you have 2-4 unit vacation rental properties, this option would be more suitable for investors. Apart from that portfolio loans fall under this category along with government-back loans, conventional mortgages, and short-term multifamily loans.

Short-term Loan

This option is more for investors who are in need of quick cash in purchasing a vacation rental property. Bridge loans and hard money both fall under this group.

How To Estimate Vacation Rental Potential?

How To Estimate Vacation Rental Potential?

If you are thinking of investing in a vacation rental property but having some doubts on how to evaluate what makes a good return investment property, simply follow the below formulas to help estimate a vacation rental’s potential:

Occupancy Rate

Before investing in a vacation rental property, the main areas to focus on are to get bookings and maintain a good occupancy rate though keep in mind this does not assure it will generate a consistent income.

With that said, a good occupancy rate allows hosts to charge an average rental rate that maximizes vacation rental income.

Formula: Airbnb occupancy rate = The number of booked nights/The number of total available nights

Cash Flow

In simple terms, cash flow is a pretty straightforward metric for evaluating vacation rental potential. It is the total monthly income received minus the overall monthly expenses. Things like property tax, mortgage, insurance, management fees, utilities, cleaning fees, and rental income tax are monthly expenses to take into account.

For anyone who is investing in vacation rental property, it is important to have positive cash flows, especially at potential locations. Positive cash flows are when the income is higher than rental property expenses.

Formula: Cash flow = Monthly rental income minus Monthly rental expenses

Cap Rate

The capitalization rate is how much profits are made in contrast to the value of the investment property where a good cap rate will range from 8% to 12%. On the other hand, the net operating income is the difference between the operating vacation rental expenses such as taxes, maintenance, etc., and the gross rental income.

Formula: Cap rate = Annual net operating income (NOI)/Vacation rental price

Cash on Cash Return

Based on how much you have invested on a vacation rental property, cash on cash return is the percentage of profit you have capitalized depending on factors such as income property type, location, and more. Though, bear in mind, cash on cash returns vary and should be anything 8% to 12% or more.

Formula: Cash on cash return= Annual pre-tax cash flow/Total cash invested

Rent-to-value Ratio

The rent-to-value ratio is the yearly rental income you earned against the overall value of the property. Bear in mind that it varies between 3% and 10% though preferably consider vacation rental properties that have the rent-to-value ratio of 5% or more.

Bottom Line

When you decide to invest in a vacation rental property consider steps before taking the leap. Without a doubt, it is a lucrative business. And without the right and proper preparation, your vacation rental property business could possibly incur losses.

Therefore, it is important to do research on the local real estate market before deciding on investing in a property. More importantly, you may find investing in a vacation rental property is worth the risk as it benefits you with tax write-offs, increased cash flow, and so much more.

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