Airbnb and VRBO --- Why have so many investors flocked to Short Term Rentals?
Airbnb and VRBO have become synonymous with innovative real estate investors. While there are positives and negatives to their impact on communities, real estate development ideas, and growth patterns, this movement is impossible to ignore. Airbnb burst onto the public markets in late 2020, in a year marked with wild swings of the stock market and economic uncertainty. However, their stock surged and has not shown any signs of slowing.
The Coronavirus pandemic decimated the hospitality and travel industry, yet most Airbnb owner operators are not in a notably worse condition than they were at the start of the pandemic. Overall, this speaks to the lack of specialty use that most Airbnb properties experience, therefore the flexibility to switch back to long-term rental, or some other type of intermediate rental. The resiliency of this asset class is quite impressive. In evaluating short-term rentals, it is important to look at the history of them and why they have grown so rapidly. Additionally, taking a look at important factors for investors to know regarding potentially different tax treatments for their rental activities based on their involvement in the operations.
How the Airbnb Revolution Started
The last 12+ years have been full of ups and downs for real estate investors. The Great Financial Crisis left many newer homeowners and landlords upside down on properties they purchased in the housing market explosion between 2005 and 2008. It didn’t look like there was any letting off the gas, with demand far outpacing supply. However, when the mortgage market turned upside down with a massive wave of foreclosures, it became impossible for most to obtain a mortgage and if you were able to get one, felt like a never ending request for paperwork. It was right in the middle of this real estate crisis that one of the biggest names in technology was born. Airbnb was started in San Francisco by a few roommates that were trying to make some extra cash renting out an air mattress in their living room. The rest is history, and has caused waves in the real estate investing world.
The growth of Airbnb was slow to start, with the Presidential inauguration in 2009 being a pivotal point in the company’s history. Their model was put to the test and succeeded. Over the following few years, their network grew across the world. Starting in major metropolitan areas as an inexpensive alternative to hotels and motels, Airbnbs have quickly become accommodations that families, college roommates and location independent workers have begun to rely upon for short and long term stays in furnished homes and apartments. This growth in popularity, even in smaller cities has led to landlords considering how they might use their properties in a different way, and has also spurred a new business model of arbitrageurs seeking to lease space on a long-term basis and re-rent it on a short-term basis.
The investment case for STRs
In many cases, the cash on cash return of a unit, even after accounting for higher operating expenses, is twice what an investor might make on a long-term rental. Some investors have found ways to scale this business model to have 50+ units under management, while maintaining relatively low overhead costs. However, this business model is much more capital intensive as well as management intensive. In many cases, a single unit will be cleaned and “flipped” upwards of 8 times per month. The owner or landlord might not be the one doing the cleanings, however, there must be very good systems and controls in place to ensure that ratings stay high and guest satisfaction is maintained.
It has also increasingly become popular for homeowners to rent out extra space in their home, what many refer to as “househacking”. Airbnb can be perfect for this. Whether it be a basement or garage apartment, it allows the homeowner to have flexibility when they want to have guests in the house and when they want to take a break. It turns out this can be a perfect way for newbie investors to get their feet wet in real estate investing. It could be taking advantage of low down payment mortgages on primary residences that are Duplex, Triplex, or Quadplexes; or a home that has an Accessory Dwelling Unit (ADU). In many cases, with interest rates at historic lows, new investors many times find that renting out a single bedroom on Airbnb might cover their monthly mortgage payment.
The incumbent platform and technology advances
Vacation Rental By Owner (VRBO) is also a great platform for vacation rental investors as well. Having been started in 1995, VRBO has the reputation for being an early moving alternative to locally managed beach or mountain vacation rentals. Many investors are now realizing that combining technologies like a property management system, Internet of Things (IoT) technologies like smart locks and thermostats, and universal adoption of cell phones, it is possible for an individual to self-manage a vacation rental hundreds or even thousands of miles away. For investors seeking higher returns in a market where valuations are stretched and yield is low, this is an appealing factor.
The combination of all these factors, we are seeing more and more part-time investors becoming full-time investors because it takes less capital to produce more income! This is a great thing, but it should be remembered that running an AirBnb business is anything but passive income! Unfortunately, there are lost keys, dead batteries, parties, and unhappy guests to deal with. This might be an occasional issue for long-term rentals, but it is a daily job for those managing multiple STR properties! However, with this active involvement may come with different tax treatment.
Active Business or Passive Investor?
There are 7-day and 30-day rules a STR owner must consider. If the average customer uses the property for 7 days or fewer, or 30 days or fewer if the owner provides significant personal services, then the activity is not treated as a rental and will be treated as a trade or business. The rules in determining whether the activities are passive or active trades or businesses is complex, and it is always recommended to have a tax professional involved. However, if a STR owner is considered an active business owner, that also makes them eligible to establish a retirement savings plan based on the activity. It can also pull in other expense deductions necessary to run the business that typically would not be allowable with a Schedule E passive rental. These expenses include expenses like home office deduction, health insurance costs, vehicle expenses and to an extent business meals.
Short-term rentals are a powerful way to get into real estate, but might not be sustainable for the long-term, especially if your goals are for financial freedom without being “on call” 24/7. I am finding that many investors use STRs to get into real estate, then eventually move the properties to long-term rentals as a long-range plan to still be an investor, but move themselves onto the passive side of the equation. This is a natural evolution of investors and as the household need for higher cash flow falls, so might the desire to enjoy some of the great benefits of being a real estate investor. Those benefits primarily being the tax benefits, the mailbox money, the debt paydown and the long-term appreciation that makes real estate such a powerful investment.
About Daniel:
Daniel is a real estate investor, small business owner, AirBnB operator and trusted financial planner. I started RE|Focus Financial Planning, a boutique planning firm focused on working with real estate investors and small business owners. As a CERTIFIED FINANCIAL PLANNER™ professional, I help successful individuals and families gain clarity on their current situation and future goals. If that sounds like you, let’s have an introductory conversation to learn more.
