Airbnb and VRBO aren’t just having an impact on how travelers find a place to stay—many people are choosing to invest in vacation properties, with the express intent of offering them as short term rentals during popular travel seasons.
We can say from our personal and professional experience that the numbers do add up. Last year in a survey of homeowners who rent out their homes on HomeAway.com, 70% of respondents said they could pay more than half their mortgage with rental income.
As long as the property is located either near a large body of water and/or in a popular tourist destination—such as Lake Tahoe or San Francisco—it’s very realistic for property owners to pay the entirety of their mortgage with rental revenue.
Owners often do find themselves debating whether long-term or short-term rentals are the best approach. Short-term rentals generally produce more revenue, but are also more expensive to operate than a traditional rental, due to the expense of cleaning, laundering, restocking toiletries, as well as the necessity of providing furnishings.
In the past, short-term rentals were simply too inefficient to justify the expense. You would have to advertise through a local newspaper or management company, which presented two problems: the advertisement represented yet another expense, and the limited geographic nature of the advertisement meant that you couldn’t reach tourists who planned on visiting the area. And of course, this limited reach made it difficult to obtain bookings with any consistency. Thus, long-term rental was the only realistic option.
But now, short-term rentals are exploding in popularity, for obvious reasons. For the price of a decent hotel room, travelers can now stay in a full-sized house with a kitchen, multiple bathrooms, outside areas, and more. Even properties that wouldn’t necessarily be thought of as appropriate for short-term rental are being converted for short-term use, and are performing well.
For instance, the owner of a fourplex in the Lake Tahoe area might be able to rent each unit out to locals for $1,000 per month, whereas on Airbnb, each unit can fetch $150-$200 per night. Even factoring in cleaning costs and nights with no occupancy, net income after expenses for short-term rental can be 50% to 100% higher than what would be realized from long-term rental.
As a result, second-home buyers who in the past might have compromised with a smaller vacation home—or a home located in a less attractive area—can instead afford to splurge on incredibly attractive homes with larger mortgages, and still have the opportunity to enjoy staying in their property some of the year.
However, financing the purchase of vacation real estate can be a challenge.
Lenders typically don’t like making large loans on investment properties. Fannie Mae’s cutoff is $417,000, and most other lenders max out at $624,000. While a would-be homebuyer’s first inclination might be to turn to a bank to make up the difference, most banks don’t like offering a secondary loan on top of a Fannie Mae loan.
Part of the problem is that banks have no reliable source of data for the vacancy rates on a particular piece of property. Also, appraisers and underwriters don’t use short term rental rates when looking at rental properties. This means that homes that are ideal candidates for short-term rental are essentially undervalued with regard to their potential to generate income, and your ability to pay the mortgage is underestimated.
Frankly, second-home buyers are in something of a catch-22. If they label the second home as not being a source a profit, lenders factor in the cost of mortgage payments on the buyer’s primary home. The result is that few buyers can get their debt-to-income ratio below the target of 43% to 45% necessary to obtain a mortgage. But if they categorize the home as an investment, they’re completely ineligible for a second-home mortgage.
This is where hard money lenders like Socotra Capital can help. We understand the real estate market, and we are confident that Airbnb and VRBO are going to help drive the housing market in popular California travel destinations, such as San Francisco, Los Angeles, San Diego, and Lake Tahoe. And as the short-term rental market becomes increasingly efficient and utilized, the value of desirable properties will continue to go up.
Real estate investors that target these markets and take advantage of online rental platforms will likely see a handsome profit, thanks to the ability to immediately generate revenue and offset mortgage costs.
