For many people the prospect of buying a vacation rental is a far away dream. After hundreds of conversations, it's become clear that people tend to overthink the entire process. While careful planning and due diligence is important, it's equally as important to not get analysis paralysis.
Like any property purchase there is a certain level of risk that you need to take in order to pull the trigger. By reading this article hopefully you feel more prepared and understand the key things to consider when you’re looking to buy a vacation home.
Portfolio Diversification - By purchasing a vacation property you’re diversifying your overall finances. It's likely you already have a primary home, savings, and some exposure to the stock market. By doing those few things you already have a well-diversified portfolio, but you can take it to the next level by acquiring real estate properties in high-demand tourist destinations.
Appreciation - The holy grail of real estate is when your property appreciates in value. Let's say you purchase a vacation home for $500,000 and ten years later you decide to sell it for $1,000,000. In that example you would have realized $500,000 in appreciation over your initial investment. In the real estate market it is not unusual for properties to double in value over a ten year timeframe.
Cash Flow - In most cases, homeowners looking to invest into a vacation rental are hoping that the property will at least cover the cost of itself each month. If the property costs you $2,000 per month then hopefully you’re able to generate that much as a vacation rental, right? Wrong, in many markets the vacation property will generate far more than the cost to own, meaning you will have a net cash flow each and every month.
Tax Advantages - There is a reason why the ultra-wealthy love real estate and that is largely due to the tax advantages to owning a rental property. Just like conventional rental properties, vacation rentals offer huge tax advantages. Write off the interest payments on your mortgage, strata fees (HOAs), property taxes, furnishings, maintenance and repairs, and advertising.
Consult with your tax attorney and accountant to maximize the tax advantages available to you.
Personal Use - By owning a vacation rental property you have the ability to utilize the property whenever it is not being occupied by a guest. This lifestyle boost is a major reason why so many people are fascinated by the idea of owning a vacation rental.
Pride of Ownership - Money and usage aside, all of the homeowners we speak to thoroughly enjoy and take pride in owning their vacation property. In many cases the property is the family's trophy property which they have celebrated years of joyful memories and milestones.
Mortgage - A vast majority of property purchases will be done so by obtaining a mortgage from a lender. The cost of a mortgage will vary significantly based on the purchase price. As mentioned above, the interest expense if a tax write off, while the principal payments are actually equity building, meaning each month that you pay your mortgage your net worth increases.
Strata Fees (HOA) - If you’re purchasing an apartment or property governed by a strata corporation you will be required to pay fees to maintain the building and any amenities the building offers. Of course, strata fees can vary, but it is not uncommon for these fees to be between $300 - $800 per month.
Insurance - Insurance is a common cost of owning real estate, anyone who owns a home already knows that insurance is a cost that you will have to absorb. In regards to vacation rentals it is important that you notify your insurer and let them know that you intend on renting the property out on a short term basis.
OTA Fees - Online Travel Agencies are the booking platforms that we all know and love: Airbnb, VRBO, HomeAway, and Booking.com. These booking platforms all take fees from the homeowner. While it is possible to generate direct bookings, it is unlikely that you will be able to completely avoid OTA fees.
Furnishings - The cost of furniture will vary greatly depending on the size and quality of your home. It is common for new homeowners to purchase all brand new high-end furniture. In most cases this is not necessary. Also keep in mind furnishing a vacation rental goes beyond just beds and couches, you will need to supply anything needed during the course of a guest stay such as coffee makers, pepper shakers, a plunger, etc.
Linens & Towels - Yes, linens are a significant cost when it comes to owning a vacation property. The general rule of thumb is to budget three sets of linens for each bed. This will provide you with a clean set ready for the next guest, a dirty set that needs to be cleaned, and a spare set in case you have an unexpected stain.
Incidentals - Guests expect to have the essentials when they stay at the property so you need to budget accordingly. Typical costs included in a stay are: shampoo, conditioner, hand soaps, toilet paper, salt and pepper, and basic cooking supplies.
While this cost is not substantial, it is still an important expense to factor into your overall budget. It is not uncommon for incidentals to cost between $500 - $700 per year.
Professional Cleaning - Cleaning is one of the most costly expenses of running a short term rental business. It is also one of the most important factors to ensuring guests feel comfortable and safe. A dirty property is a sure-fire way to receive a poor review. Most cleaning companies charge between $30 - $45 per hour for their professional cleaning services.
Repair & Maintenance - Like any property, your vacation rental will also experience general wear and tear. It is important to maintain your property to be showroom ready at all times, so you should budget 1-2% of the home value for maintenance and repairs.
Before jumping into buying a vacation rental it is super important that you calculate the numbers correctly. BiggerPockets is an excellent resource with several calculators to help real estate investors determine the feasibility of their purchase.
In general, you will want to follow this formula to calculate the ROI:
ROI = (Gain on Investment - Cost of Investment) ÷ (Cost of Investment)
When thinking about buying a vacation rental it is important to ask yourself, “who will manage the property?”. Ever since the birth of OTA’s like Airbnb many homeowners have decided to self-manage their vacation rental, rather than partner with a vacation rental management company. These companies typically take 40-50% of the bookings as remuneration for providing guest communication and support. For many homeowners that is a high cost to pay when they can simply manage the property themselves.
By managing the property yourself you will be able to save a lot of money. Additionally, most self-managed properties tend to have a uniqueness to them that can be difficult for conventional management companies to recreate.
Working with a vacation rental company makes sense when the distance between you and your vacation property is significant. If you’re further than a 30 to 45 minute drive from your recreational property then it is advisable to work with a vacation rental company to provide the “boots on the ground” support that you will need.
It is common for vacation rental management companies to charge between 25 - 40% of the value of the reservation. This may seem like a large expense but for many the peace of mind knowing that someone looking after one of your largest investments is worth it.