Traveling for leisure is one of the greatest pastimes in America and around the world.
Certain destinations in the United States are incredibly popular with travelers and have been for decades.
For example, travelers love Branson, Missouri, for live entertainment. The Florida panhandle is known for its beautiful, family-friendly beaches. The North Carolina Outer Banks are known for their rugged coastal beauty. These are just a few of the many places where people consider buying vacation homes so they can not only personally enjoy them but potentially rent them out.
The vacation rental market is massive and growing, thanks in large part to the growth and popularity of home-share sites.
Vacation rentals are a major part of the modern travel ecosystem.
A few interesting statistics include:
- The U.S. vacation rental industry’s total revenue was estimated at more than $13 billion in 2021. The year-over-year vacation rental market has seen a growth rate of 10%. By 2025, based on current trends, it’s estimated the industry will be close to $20 billion.
- By 2025 research shows almost one in five people will have stayed in a vacation rental.
- According to a 2016 study, there are a few key reasons people book rentals. They want access to a kitchen, and they also like that rental afford them more privacy and space than a traditional hotel.
- During the pandemic, rentals did better than other forms of lodging.
- Hotel companies are trying to get involved in the vacation rental industry because of its growth. For example, in 2019, Marriott debuted Homes & Villas by Marriott International. The program started with 2,000 properties and now has tens of thousands throughout the world.
- Vacation renters are trending toward booking longer stays. For example, before March 2020, most bookings were for a week or less. After the pandemic, only 30% of all reservations were under seven days. Most were longer.
Those statistics can make the idea of investing in a vacation rental appealing, particularly in a high-demand area like the ones listed above. At the same time, it’s not something without challenges.
Below we talk more about what you should know and how you should prepare to invest in a vacation property, and what the risks can be.
An Overview of Buying a Property As a Vacation Rental
If you’re thinking about investing in a vacation rental, there are differences between this and investing in traditional real estate. You have to understand the local market well or hire a real estate professional who does. You also need to figure out the projected revenue.
Location is the top priority you have to keep in mind when investing in a vacation property. That’s more important than anything else, and it’s what can’t be changed.
The more specific you can be as you decide on a location, the better. You need to think about the weather, the market conditions, amenities, demand, and things like flooding, taxes, and the type of insurance you would need.
Even if you find a beautiful property, if it’s not in an area that would be in demand for travelers, it’s not going to be a worthwhile investment.
You want to think about whether you’d want to vacation in the area and how close a property is to certain attractions that the location is known for. What will the seasonal fluctuations likely look like?
The income generated by a vacation rental depends on the season, unlike a traditional rental property. If you buy something near a ski resort, winter is your prime time. In a coastal area, it’s summer. You have to know how the peak seasons are going to influence your monthly expenses.
Financing Vacation Rentals
If you’re financing an investment, then there are differences between a vacation rental and a primary residence or a second home. A vacation home can fall into the second home category, but with some differences.
To be considered a second home, you must occupy the vacation property for part of the year. The property must be suitable and accessible for year-round occupancy, and it has to be a one-unit dwelling. To be considered a second home in the eyes of a lender, the property can’t be subject to property management, timeshare, or rental agreements.
A second home isn’t meant to be used as a rental property. Mortgage lenders view second homes as something you’re going to enjoy and live in a part of the time.
If you want to rent out of your property most of the time and you won’t be visiting much, you’ll need an investment property loan. An investment property loan is going to have higher mortgage rates and stricter lending requirements.
Some lenders are getting more flexible in letting a homeowner of a vacation property generate rental income, but they still have to occupy the home some of the time.
If you own a home and rent it for fewer than 15 days, you don’t have to report the income according to IRS rules. However, the IRS will consider a second home an investment property if you spend fewer than two weeks in it and then try to rent it out the remainder of the time.
Any rental loss is considered a passive or hobby loss by the IRS. They can only be written off against your income for other passive activities. Passive losses you can’t use are then carried forward until the point you sell the vacation home. When you do sell it, you can use your losses from the past to offset gains.
Analyzing a Property
One of the biggest risks of investing in a vacation rental is not getting the returns you want or need to make it worth. Your goal is to make enough so that you can cover your costs and earn a profit.
To reduce the risks associated with buying this type of property, you should crunch the numbers beforehand.
There are online calculators you can use to analyze your potential rate of return. You can also generate reports on cash flow, recurring monthly expenses, the project occupancy rate, and the tax history.
What Are the Pros and Cons of Buying a Vacation Rental Home?
As with any investment, there are pros and cons to vacation rentals. The following are things to consider in the process:
The Pros of Buying a Property to Rent
The following are some of the upsides of being a vacation rental owner:
- Of course, the big upside is the potential to earn income. On average, Airbnb hosts earn $900 a month. Hosts in very in-demand locations make four times that or more. There are also many other vacation rental platforms you can use.
- If you do want to use the home, it’s available. You should think about where you like to visit when you make a buying decision, even if it’s not your biggest priority.
- You can write off a lot of your expenses if you rent the home out for more than 14 days, at which point it’s considered a business for purposes of your taxes. You do have to pay taxes on the income it generates, but you can also write off a lot of your expenses. Some of the things you might specifically write off if you’re a rental investor include cleaning costs, hosting fees, supplies, insurance premiums, utility costs, and property management fees.
- You can use a vacation home as a tool for building long-term wealth, and it’s a good part of a retirement strategy.
What About the Risks?
The possible downsides of buying a vacation rental can include:
- You have to figure out a way to manage the property. It’s not a set-it-and-forget-it source of passive income. A vacation rental is very hands-on and requires a lot of work, or else you have to pay someone to manage it. A property management company might take anywhere from 15-40% of your rental income.
- You have to market it and keep it rented.
- Not every location or neighborhood allows short-term rentals. You have to be careful to understand the restrictions before buying anything.
- You’re going to have an extra monthly mortgage payment, which can create cash flow issues. You also have a number of other expenses you’re going to be responsible for.
- When you invest in a vacation rental, you almost always pay more for financing. A property loan for investment usually comes with higher interest rates than other types of mortgages. Your monthly payment will likely be higher as a result, and you’ll pay more interest through the life of the loan.
Vacation rental properties can be a great way to build wealth and earn an income consistently, but only if you’re strategic before you make a purchase. A vacation rental isn’t inherently a good investment. Only certain properties are going to fit the criteria to be a good investment, based on everything from the location to how likely it is to stay rented on a regular basis.