One of the fastest-growing segments in the housing market in the USA today is the residential rental market. This is proved by the rise in demand by over 30% in the last three years for single-family rentals, popularly called townhouses or detached homes. Neighboring Canada is not far from this trend with almost one-third of the country’s homes being rental units, a mix of apartments and condominiums.
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At the same time, the short-term, or vacation, rental market is also booming. The popularity of online marketplaces like Airbnb, HomeAway, and VRBO has helped the short-term rental market become one of the fastest-growing segments in the travel industry.3
Now, more than ever, there is an abundance of opportunity for real estate investors. But which path is best: leasing your property to a long-term tenant, or renting your property to travelers on a short-term basis?
In this post, we examine the differences between the two investment strategies and the benefits and limitations of each category.
WHY INVEST IN A RENTAL PROPERTY? The Top 5 Reasons
Before we delve into the differences between long-term and short-term rentals, let’s answer the question: “Why invest in a rental property at all?”
Why do investors choose real estate over other investment vehicles? Here are five key reasons for doing so.
- Appreciation
One of the common traits of real estate around the world is appreciation in prices. Even if recessions occur, the value of your property might dip in the short term but will recover in the long term. Hence, whenever you have an intent to get high returns on your investment, search for homes to buy and rent out.
- Cash Flow
Investing in real estate assures a steady income and cash flow. You can use the income from rent to pay your mortgage as well as keep provisions for maintenance and taxes. For example, if you are buying a house for a couple in mind, you are likely to get a high rent as most couples prefer comfortable living and are willing to pay well for it. Here, apart from the payments, you will have some savings every month.
Even if you are buying a house from the spouse in case of a divorce or separation, you will be benefitted too. Give it out on rent and you will be able to put down the mortgage payments every month. Simultaneously, as the mortgage amounts go down, the equity of your house rises until your property is free and clear. You are thus left with rental income for years to come.
- Hedge Against Inflation
The rate at which the price of goods and services increases is called inflation. It eats into your savings and lowers your purchasing power as you can buy less with the same amount of money as prices soar. However, if you have invested in real estate, the price of your property appreciates over time and sometimes exceeds the rate of inflation. Hence, if you buy out a house, it is a smart investment decision as it acts as a hedge against inflation.
- Leverage
Leverage is using borrowed capital to increase the potential return on investment. For example, you search for a home, make a small downpayment, and finance the rest of it. Over time, the value of your investment appreciates and the equity on your home rises as you pay off the mortgage. Hence, you stand to gain on the combined value of the whole property even though your stake initially in it has been quite minimal. - Tax Benefits
There are several ways that investment in real estate leads to tax benefits. From deductions on depreciation to exemptions on mortgage payments made, you save a lot of money on taxes. Consult a tax consultant for professional advice when you buy out a house as an investment in real estate.
These are just a few of the many perks of investing in real estate. (For more detailed information, visit our previous post: Why Real Estate Investing Makes (Dollars and) Sense. [Link to October 2017 blog post.]) But what’s the best strategy to maximize returns on your investment property? In the next section, we explore the differences between long-term and short-term rentals.
LONG-TERM (TRADITIONAL) RENTAL MARKET
When investors buy real estate, the focus is owning property to rent out and get an assured steady stream of income. They would prefer buying a house for a couple to take on rent on a long-term basis. Hence, the income as rent is in addition to the appreciation of the value of the property. The assured and predictable income in the long term is one of the crucial benefits of buying a house for rent in the long term.
Adding to the benefits is zero running expenses for your property. Furnishing the property or paying utility bills is the responsibility of the tenants. Moreover, traditional tenants usually stay for years together, eliminating the task of day-to-day management of your property. Taking all these factors into account, long-term rentals are an attractive option to get high returns on investment in real estate.
However, there are also limitations to long-term rentals, which often come down to your ability to control the property. Perhaps the most obvious one is that you do not get to use the home or closely monitor its upkeep (this is different from a short-term rental, which we’ll share in the next section).
In addition, while you can usually generate a steady, predictable income stream with a long-term rental, you are limited in your ability to adjust rent prices based on increasing or seasonal demand. Therefore, you may end up with a lower overall return on your investment. In fact, according to data from Mashvisor, in the 10 hottest real estate markets, short-term rentals produced “significantly higher rental income” than long-term rentals.4
SHORT-TERM (VACATION) RENTAL MARKET
Short-term rentals, often referred to as vacation rentals are a huge fad today among travelers. They get to enjoy all the amenities of home while being on vacation with friends and families. Holiday rentals have grown steadily over the years and are expected to reach a high 21% of the worldwide accommodation market.
Invest in a short-term rental and you can buy your second home from the rentals accrued from the first. The best option is to buy out house in a good tourist destination. Not only will you get assured rentals throughout the year but you can also enjoy there during non-rented periods. Further, your rental income is not fixed and you can increase the tariff many times over during peak tourist rush season to maximize the return on your investment.
But short-term rentals also have risks and drawbacks that may dissuade some investors. They require greater day-to-day property management, and owners are typically responsible for furnishing the property, upkeep, and utilities.
And while rental revenue can be higher, it can also be less predictable based on seasonal or consumer travel trends. For example, a lack of snowfall during ski season could mean fewer bookings and lower rental revenue that year.
In addition, laws and limitations on short-term rentals can vary by region. And in some areas, the regulations are in flux as residents and government officials adapt to a new surge in short-term rentals. So make sure you understand any existing or proposed restrictions on rentals in the area where you want to invest.
Urban centers or suburban communities may be more resistant to short-term renters, thus more likely to pass future limitations on use. To lower your risk, you may want to consider properties in resort communities that are accustomed to travelers. We can help you assess the current regulations on short-term rentals in our area. Or if you’re interested in investing in another market, we can refer you to a local agent who can help.
WHICH INVESTMENT STRATEGY IS RIGHT FOR YOU?
Now that you understand these two real estate investment options, how do you pick the right one for you? It’s helpful to start by clarifying your investment goals.
If your goal is to generate steady, predictable income with less time and effort spent on property management, then a long-term rental may be your best option. Also, if you prefer a less-risky investment with more reliable (but possibly lower) returns, then you may be more comfortable with a long-term rental.
On the other hand, if your goal is to purchase a vacation or second home that you’ll use, and you want to defray some (or all) of the expense, then a short-term rental may be a good option for you. Similarly, if you’re open to taking on more risk and revenue volatility for the possibility of greater investment returns, then a short-term rental may better suit your spirit as an investor.
But sometimes the decision isn’t always so clear-cut. If your goal is to purchase a future retirement home now to hedge against inflation, rising real estate prices, and interest rates, then both long- and short-term rentals could be suitable options. In this case, you’ll want to consider other factors like location, market demand, property type, and your risk tolerance.
HERE OR ELSEWHERE … WE CAN HELP
If you’re looking to make a real estate investment—whether it’s a primary residence, investment property, vacation home, or future retirement home—give us a call. We’ll help you determine the best course of action and share insights and resources to help you make an informed decision. And if your plans include buying outside of our area, we can refer you to a local agent who can help. Contact us to schedule a free consultation!
The above references an opinion and is for informational purposes only. It is not intended to be financial advice. Consult the appropriate professionals for advice regarding your individual needs.
Sources:
- USA Today –
https://www.usatoday.com/story/money/personalfinance/real-estate/2017/11/11/renting-homes-overtaking-housing-market-heres-why/845474001/ - The Globe and Mail –
https://www.theglobeandmail.com/real-estate/the-market/article-demand-for-rental-housing-in-canada-now-outpacing-home-ownership/ - Phocuswright –
https://www.phocuswright.com/Travel-Research/Research-Updates/2017/US-Private-Accommodation-Market-to-Reach-36B-by-2018 - Rented.com –
https://www.rented.com/vacation-rental-best-practices-blog/do-long-term-rentals-or-short-term-rentals-provide-better-investment-returns/ - Turnkey Vacation Rentals –
https://blog.turnkeyvr.com/short-term-vs-long-term-vacation-rental-properties/
