Investing in Vacation Rentals: Ultimate Guide

With the rise of online rental platforms such as Airbnb and VRBO, vacation rentals have become an increasingly popular choice for travelers seeking unique and personalized accommodation options. As a result, investing in a vacation rental property allows investors to tap into a growing market and capitalize on the demand for alternative lodging options.

By carefully selecting the right location and property type, investors can maximize their returns and build long-term wealth through their vacation rental investment. Continue reading to learn how investing in vacation rentals works.

What Are Vacation Rental Investments?

Vacation rentals are investment properties located in destinations frequented for holidays or vacations. Optimal places can include coastal areas, lakes, mountains, other areas of natural beauty or major cities. When you invest in vacation rentals, you purchase a property with the express intention of generating short-term cash flow through rental income and gaining long-term appreciation of value.

These investments are attractive to investors because of the flexible nature of returns. Done well, vacation rentals can produce positive cash flow from the first year, while these destinations can also generate significant appreciation over time.

Likewise, since the property will have vacancies, you have the option to block out a week or more for your family to use the property, offering the benefits of a second home without the associated costs. Buying a vacation rental property can be a way to create family memories and long-term wealth.

How Does Investing in a Vacation Rental Work?

When you invest in a vacation rental, you purchase a property with the intention of renting it for short-term stays, usually a few days to a week. For a successful vacation rental, the property must be a desirable tourist destination or another area with high demand for short-term rentals. Ideally, choose an area with demand that surpasses supply to increase the chances of low vacancy rates.

Profitable areas include established vacation destinations and emerging markets with untapped potential. The more well-established an area, the more costly the property will be and the lower overall risk you'll take on. Avoid oversaturated markets where a significant portion of vacation rentals remain vacant during peak times. For this, research the area, compare rental rates and occupancy rates of comparable properties and consider demand factors that could drive future growth.

After you purchase the property, you can list it online on sites like Airbnb, VRBO, Rent Like a Champion, Facebook, or your own website. When a client books the property, you'll need to arrange to have it cleaned and give them the key on arrival. Some vacation rental owners hire a management company to coordinate cleaning, arrival and other guest needs, while others manage everything themselves.

How to Invest in Vacation Rentals

If you're ready to invest in a vacation rental, here are the steps for buying vacation rental property.

1. Research and Identify the Ideal Location

Researching and identifying an ideal location is the most important step. Like the three bears, you want a location that is just right, neither too busy nor too remote. Look for areas with strong tourist demand and low vacancy rates during peak times. Popular vacation destinations are the obvious choice. Consider locations from the eastern seaboard to California, Florida, the Oregon Coast, ski areas, national parks or major cities like New York and Atlanta.

Ideally, choose a location you're familiar with or travel there to get a feeling for the area. Once you've narrowed your search to a few locations, research the local demand, occupancy rates and rental prices to understand what you can expect. Remember that prices and demand can be hyper-local, with one block in either direction changing potential profits.

The ideal market will offer high rental income in proportion to property prices. If you plan to purchase a home for $500,000 but local rental prices are a maximum of $100 a night, your profitability will be low. If the home price is $200,000 and rental prices average $200 a night, your return on investment could be significantly higher.

2. Set a Budget and Plan Financing Options

To determine how much you are willing to invest in purchasing a property, consider total expenses, available assets and additional expenses associated with property ownership. Take into account whether you'll need to perform renovations, as well as costs for furnishing and ongoing expenses like property management and maintenance.

While you can secure a mortgage for a vacation home investment, you'll usually need a larger down payment than on your first property. Consider whether you have the savings for a down payment or plan to pay for the property in cash.

3. Understand Local Regulations and Restrictions

Familiarizing yourself with local zoning laws is essential. Perform due diligence to determine whether you can use the desired property for short-term rentals and what permits you'll need. Check short-term rental regulations in the chosen location to understand limitations and risks.

To get a comprehensive understanding of the legal aspects of short-term rentals, you can start by researching local laws online. Then, hire a local lawyer to perform due diligence and examine zoning or regulatory risks related to the potential investment property.

4. Analyze Potential Rental Income and Expenses

While the term vacation rental can conjure images of large monthly income, that's not always the case. It's essential to conduct a thorough financial analysis of income and expenses. Estimate rental income with a 40% occupancy rate to protect your cash flow in low vacancy periods.

Plan on 3% of property value for maintenance and ongoing repairs. Add in management and cleaning costs if you won't do this yourself. Property management fees average close to 25% of rental income. In addition, you'll need to budget for utilities, subscriptions and other services you offer at the property.

Example

If you hire a property management company and pay $50 for cleaning after each rental, the average cash flow could look like this:

Income

• Rental income: $200 per night
• Assuming a 40% occupancy rate with an average stay of two nights, income would be $29,200 annually

Expenses

• Cleaning costs average $3,650
• Management fees average $7,200
• Maintenance average of $5,000 per year
• Utilities average $2,400 per year
• Insurance averages $2,000 annually
• Property taxes (varies)

After deducting expenses, you could expect an annual income of about $12,600. After deducting mortgage payment costs and property taxes, your net income could be close to $0 or even negative. On the other hand, if you paid for the property in cash, this formula gives you a managed property with a positive cash flow of close to $1,000 per month.

5. Determine the Type of Vacation Rental Property

Different property options include condos, single-family homes, apartments or duplexes. Generally, single-family homes will command the highest price, although each property offers pros and cons. Apartments or duplexes may be located in managed complexes, with higher monthly fees, but guests can enjoy additional amenities like pools, tennis courts or other recreational facilities.

Consider your total budget, target market and return on investment. Research the popularity of each property option for your desired market. For example, are single-family homes popular in a particular destination, or are apartments more common? What offers the greatest value within your budget?

6. Network and Build a Reliable Team

Connecting with local real estate agents, property managers and service providers can help you find excellent investment opportunities and deal with issues later on. They can recommend other local contacts, from service providers or maintenance staff to short-term rental insurance providers.

Attend networking events, join online groups and reach out directly to these professionals to establish rapport. Tell them about your investment goals, and ask them for their advice on the area. Building a trustworthy support network can increase vacation rental success while allowing you to support local business people.

7. Purchase the Property and Choose a Management Process

When you purchase a vacation rental, you'll follow the same basic procedure as any other property purchase. Here is how to buy a vacation rental property:

1. Get mortgage pre-approval.
2. Sign an initial purchase contract and make a deposit.
3. Perform due diligence, including property inspection and a title search.
4. Close on the property and finalize the sale.

Once the sale closes, you'll need to consider who will manage the vacation rental. Effective property management can make or break the success of a short-term rental property. You can manage all aspects of the rental if you live locally. However, many investors choose to hire professionals. This choice can be worth the additional costs as professionals can save investors' time and secure high occupancy rates with exceptional service.

8. Market and Advertise the Property

Like any business, you must get the word out about a vacation rental. Effective techniques for promoting vacation rentals include listing on online platforms and using social media to promote the property. You can consider targeted paid ads on Facebook or Google.

Start by creating a compelling description with professional photos. Highlight positive customer reviews and create your own website to showcase the property.

To optimize bookings and revenue ensure a positive customer experience. Pay attention to the little details, from decor to extras like a bottle of wine or fresh flowers. Ask happy customers to recommend your property online or give you a positive review. If you secure many 5-star reviews on sites like Airbnb or VRBO, those sites' algorithms also highlight your property, creating positive momentum.

If applicable, consider offering unique experiences to guests. This can be a great way to differentiate your listing and attract travelers looking for more than just accommodation.

9. Continuously Monitor, Improve and Scale

A vacation rental is a business and tracking key performance indicators, including vacancies, income and expenses is essential. Notice areas of possible improvement or where losses occur and make the necessary adjustments to increase yields. Ask guests for suggestions to improve their experience and implement relevant suggestions.

Once you have one successful property, consider scaling. You can scale the vacation rental business by expanding the property portfolio within a single market or by diversifying properties across markets.

Final Tips for Investing in Vacation Rentals

Vacation rentals can offer attractive returns through the possibility of positive cash flow along with long-term appreciation. Investing in vacation rentals in an area you love allows you to enjoy a second home while earning rental income. Like any investment, vacation rentals come with certain risks.

Research the overall real estate market for the area and consider possible growth and short-term rental demand to select a property that can offer the greatest returns in the short and long run. If you're not ready to purchase a vacation property yet, consider investing in REITs.

Frequently Asked Questions