Long Term Vs Short Term Rental
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Originally Posted On: https://www.dohardmoney.com/long-term-rental-vs-short-term-rental/
With the advent of online rental platforms like AirBnB and VRBO, many real estate investors have opted for a short-term rental strategy. Others prefer the stability of long-term rentals. This begs the question, long-term rental vs short-term rental – what’s the better option?
Short-term rentals consist of nightly and partial home rentals. They typically have higher nightly rates but need more management. Long-term rentals include one-year and longer leases. They provide stability but have lower rates. Investors need to weigh the pros and cons to decide what makes sense.
I’ll use this article to explain more of the pros and cons of both long-term and short-term rentals. Specifically, I’ll cover the following topics:
- An Overview of Short-term and Long-term Rentals
- Short-term Rentals: Advantages
- Short-term Rentals: Disadvantages
- Long-term Rentals: Advantages
- Long-term Rentals: Disadvantages
- Final Thoughts
An Overview of Long Term vs Short Term Rentals
Broadly speaking, real estate investors pursue one of two rental strategies: short-term or long-term.
The short-term strategy consists of nightly rentals, similar to a hotel. Tenants do not sign a lease, but they typically must comply with some sort of terms of service agreement. Generally, investors do this via an online listing service like AirBnB or VRBO. With this model, tenants stay places temporarily, usually from a night to a couple weeks. This could be for work, vacation, or any other short-term needs. In general, landlords charge a higher rate per night with short-term rentals than long-term ones.
Additionally, the short-term rental strategy includes the concept of partial rentals. With this approach, landlords rent out a portion of their own home. For instance, if you own a three-bedroom home, you could rent out one of the extra bedrooms on a short-term basis via programs like AirBnB. This provides a great source of extra income without major additional expenses. That is, you already own the home, so you just need to pay for the extra utilities and cleaning.
Long-term rentals generally include any landlord-tenant agreement of one year or longer. And, with long-term rentals, landlord and tenant will sign a formal lease agreement, dictating monthly rent, lease dates, and other lease terms. With this model, investors typically receive a lower rate per night when looking at monthly rent in terms of nightly rate.
Both of these models have their pros and cons. Before deciding to pursue one rental strategy or the other, investors should review the below considerations to see what makes the most sense for their unique situation and investment goals.
Short-term Rentals: Advantages
Higher Nightly Rates
As stated, short-term rentals typically provide landlords higher nightly rates. Due to their short-term nature, renters need to pay a nightly premium. For example, assume that an apartment normally rents for $1,000/month, which would translate to $33.33/night. By renting it short-term – rather than at the monthly rate – an owner could potentially command $50/ or $60/night, depending on the market.
This higher rate offsets increased likelihood of vacancy, as landlords likely won’t have renters every night in a short-term rental. But, in the right markets – especially vacation destinations – short-term rentals can remain occupied nearly every night, providing outstanding returns.
Rental Rate Flexibility
Due to the short-term nature of landlord-renter agreements, landlords have the flexibility to adjust rates far more easily. With a one-year lease, a tenant locks into a single rate for the duration of that lease. With a short-term rental, landlords can charge different rates nightly.
For instance, a short-term beach rental could charge double its average rates for Memorial Day, 4th of July, and Labor Day weekends, because demand is typically higher due to holiday beachgoers. Conversely, the same landlord could lower rates in October, as beach demand is typically lower once kids go back to school.
Build Vacation Home Equity
Related to beach properties, many investors choose to buy a rental property that they can use for vacations, as well. With booking platforms like AirBnB and VRBO, owners can create unavailable blocks of time. As such, a family could block off two weeks every summer for a beach rental for their personal use. Then, for the rest of the summer, they can rent to short-term beachgoers.
This has a two-fold advantage. First, it provides the owners access to a vacation property. Second, by renting it out while not using it, these investors have renters help – or completely – pay their mortgage. And, with each mortgage payment paid by someone else’s money, you build equity in your vacation home. Even if you don’t have positive cash flow, simply covering your mortgage builds your long-term wealth by having someone else pay down an amortizing loan.
Partial Rental Opportunities
While the idea of renting out part of your house to guests has existed for ages, AirBnB has significantly popularized the technique. Known as partial rentals, renting out a spare bedroom can be a great way to earn extra income.
You’re already paying rent or the mortgage on the property, so you don’t have any additional expense there. You’ll have mild increases in utility payments and, if outsourced, need to pay a cleaner. But, everything else is just extra income for you.
Some investors even take this approach to the extreme and rent most of their homes while still living there. Dubbed the “house hacking” approach, this lets other renters pay your mortgage for you, meaning you live for free.
Short-term Rentals: Disadvantages
Major Management Burden
Due to the constant tenant turnover, short-term rentals pose a major management burden for investors. This includes monitoring bookings, cleaning the property between tenants, and handling the maintenance that comes with any rental.
If you choose to handle all of this management on your own, you can pretty quickly become overwhelmed – especially if pursuing this strategy while still holding a full-time job. On the other hand, you can pay a company to handle everything. While this eases your management burden, the management company fee will also cut into your bottom line, meaning you’ll have to run the numbers to see if hiring someone makes sense.
With the recent rise in short-term AirBnB rentals, many cities have cracked down on this rental approach. Ostensibly, cities argue that these properties pose a safety risk, as they are not regulated by the city. In reality, AirBnB stays typically don’t face the same taxes that hotels do, meaning that cities lose out on potential tax revenue with short-term rentals.
Regardless of why cities choose to do it, many have decided to ban short-term (generally under 30-day) rentals. And, ignoring these rules can result in stiff fines for hosts. As a result, before implementing a short-term rental strategy, confirm whether it’s allowed in your city.
Similarly, many buildings have decided to ban short-term rentals. In condos, owners were renting out the units they owned. In apartments, many tenants signed long-term leases then rented out their units – or part of them – for a higher nightly rate.
These practices concerned building owners for several reasons. First, some saw this as a safety and/or liability concern, with new people coming in and out every night. Second, many building owners worried that this practice could hurt property values. As a result, many building rules and regulations explicitly ban short-term rental practices. Before buying a property with the plan to rent it out on a short-term basis, read the building bylaws closely.
Investors pursuing short-term rental strategies will likely face financing challenges, especially BRRR investors. With this investment approach, investors 1) buy a distressed property, 2) rehab it, 3) rent it out to high-quality tenants, and 4) refinance it into a traditional mortgage.
But, this refinance typically hinges upon a signed, long-term lease. To apply rental income to your debt-to-income ratio, lenders will require this sort of agreement. Lenders need a level of income security to approve an investment property loan, and most will not consider short-term income – even significant income – sufficient to support loan underwriting standards.
As short-term rentals become more and more popular, these lender standards may change. But, in the meantime, you’ll be hard-pressed to find a lender that will accept short-term income to meet investment property mortgage requirements.
The “Party Scene”
Unfortunately, this represents an example of the “few bad apples” situation. Most short-term tenants treat properties with respect. However, especially in vacation destinations, a tendency exists to treat short-term rentals as party houses. This can cause significant damage. And, even if investors recoup their damage costs via a security deposit forfeiture, it still takes time and energy to repair a damaged property.
Long-term Rentals: Advantages
Financial Stability and Forecasting
Long-term rentals provide investors a tremendous level of stability. Once you sign a long-term lease, you know exactly how much rent you’ll receive for the duration of the lease. Even with variable operating expenses, this continuity allows investors to plan and execute accurate operating budgets for a property. And, these budgets allow investors to conduct long-term cash-flow and investing forecasts, forecasts that enable planning for future investments.
While investors can certainly build models to project short-term rental revenues over time, they’ll inherently lack the accuracy of a long-term rental. This can prevent investors from projecting future returns – and therefore building a strategy to purchase their next investment.
Ease of Financing
Lenders worry about a borrower’s reliability. Basically, they want to confirm that borrowers have enough cash coming in to cover their monthly mortgage payments. With a demonstrated track record as a successful landlord, long-term leases can make financing far easier. As discussed above, the BRRR strategy hinges upon refinancing a property from a hard money loan into a traditional mortgage. A long-term lease provides lenders far more peace of mind in approving one of these loans for an investment property.
Smaller Management Burden
Long-term leases also significantly reduce the management burden on a property. Yes, investors still need to deal with maintenance requirements. And, they still need to A) find tenants, and B) clean the property between tenants.
However, turning a unit once a year – or once every several years – proves far easier than doing so every single night. Finding and placing quality long-term tenants isn’t easy, but, once an investor does it – or pays a management company to – then they need to deal with far fewer management-related headaches. If you properly vet your tenants and establish clear operating procedures, a stabilized property should run quite smoothly.
Future Home Purchases
In addition to assisting with refinancing the current property, long-term rental strategies can assist investors with future home purchases. When an individual applies for a mortgage, the lender will review the entire debt-to-income picture, including mortgages associated on other investment properties in their name. Each lender varies, but many will recognize 75% of the rent associated with a long-term lease in your debt-to-income ratio.
On the other hand, without a signed long-term lease – even with short-term rental income – lenders often won’t recognize any income. This means meeting the DTI requirements on a future home purchase can be a huge challenge, because the mortgages on your other properties are not offset by rental income. Some lenders may accept a percentage of short-term revenues if supported by two years of tax returns. But, it’s far easier just placing a long-term lease on the table.
Long-term Rentals: Disadvantages
Lower Nightly Rates
As discussed above, long-term rentals tend to command far lower nightly rates than a short-term property. Tenants understand that, by signing a longer lease, they provide a level of stability to the landlord, and they want to receive a discount for that reality. Tenants sacrifice their flexibility to assist landlords, and this leads to lower rates.
Accordingly, landlords need to balance A) their desire for long-term stability against B) the reality that the longer the lease, the larger the discount generally required by the tenant. For instance, it’s not uncommon for a landlord to offer a one-year or two-year lease to a tenant. And, as an incentive for the two-year lease, many will freeze the rent for the entire term. Now, if that same landlord just did two sequential, one-year leases, he or she could likely increase rent at the end of Year 1. But, they’d then need to find another tenant at the end of the first year.
No landlord wants to deal with evictions, but if you rent properties for a long enough period, you eventually will – regardless of your screening procedures. And, evictions can be an absolute nightmare.
Inevitably, evictions take time. Even if the process runs as smoothly as possible, it’ll still take a few weeks – at best. Most take far longer, especially in the era of COVID-19 rent protections. During this entire period, you’re not collecting rent. Sure, you may receive a judgment if you end up taking a tenant to court, but it can take years to collect.
And, evictions always come with the possibility of tenant lawsuits. If you fail to meet local compliance requirements, you could open yourself up to liability if an evicted tenant sues you. Even if you win the suit, this will require legal fees. And, if you lose, you may need to pay the tenant damages – while still paying your own legal fees.
Unfortunately, bad tenants exist. Fortunately, a short-term tenant leaves in a matter of days. Long-term ones can act as a thorn in your side for an extended period of time. However, while no guarantees exist, landlords can minimize the likelihood of eviction proceedings with thorough tenant screening and background checks.
Even when you don’t need to deal with evictions, some tenants just pose more challenges than others. When you’ve been a landlord for an extended period, you’ll realize you rarely hear from some great tenants. On the other hand, it seems like some particularly needy tenants call you with issues on a near-daily basis.
You can avoid these headaches by hiring a property management company. That way, when issues arise, high-maintenance tenants call the management company, not you. But, as with short-term rental managers, long-term ones cost money, too.
Inability to Quickly Raise Rents
When you sign a long-term lease with a tenant, you can’t just decide to increase the monthly amount because of a holiday. Whatever you agree on, that’s the rent for the duration of the lease. In vacation areas, this means losing the ability to increase rents during peak seasons. For instance, nightly rates for a home in a ski destination go through the roof during winter breaks and long weekends. Landlords understand demand increases at these times, so they can charge renters a premium.
But, if you’ve rented a ski house year-round to a tenant, you lose the ability to adjust rents to take advantage of increased seasonal demand.
As with all investments, deciding between a short-term and long-term rental strategy requires a thorough cost-benefit analysis. Realistically, many of the pros of one option represent cons of the other. I recommend that, prior to choosing one over the other, investors rank their primary objectives. For instance, if you want to maximize profit, short-term rentals may make sense. On the other hand, if you’re seeking stability, you should probably pursue a long-term rental strategy.