Investing in Vacation Rentals

Today’s issue is a personal exploration of a topic I know quite well: vacation rentals.

A couple of months ago, as equities first began falling, Wyatt and I were spitballing about what personal investment moves we’d consider making.

Midway through our discussion of dip-buying opportunities, I remember blurting out something along the lines of, “At the end of the day it all boils down to real estate.” When faced with new buying opportunities, property is the first place my brain goes every time.

I’ve been traveling a lot lately. I’ve stayed at 6 different Airbnbs over the past 6 weeks throughout the Iberian peninsula. It’s so wonderful to see the world opened back up (well, most of it) and people exploring our beautiful planet again.

In this issue, I’m going to make a case for why I think holiday rentals are one of the best long-term alternative assets. At least for me.

Let’s explore 👇

History of private home rentals

Vacation rentals are nothing new.

Booking private apartments and homes goes back to the 1960s. Travel agents worked with hundreds of companies worldwide that helped facilitate supply and demand.

Some of these vacation rental marketplaces, including VRBO and HomeAway, even flourished in the early days of the web.

But until 2008, there was no website with a service that allowed you to book an ordinary person’s room over the Internet using your credit card.

That is, until Airbnb came along.

Airbnb got lumped in with Uber at the dawn of the “sharing economy.” But unlike Uber, which gives drivers no control over pricing, Airbnb offers hosts huge flexibility when it comes to pricing, marketing, availability, and branding. Suddenly, anyone could effectively run their own hotel business.

Love or hate the term “sharing economy” (I’m not a fan), it’s clear Airbnb is what it’s all about. They kicked the sharing economy into high gear while avoiding its negative associations, and haven’t looked back since.

Airbnb was formed during the 2008 recession. After running out of money, the founders famously sold cereal boxes to keep the company alive.

My first vacation rentals

I come from a family of hoteliers. My uncle had a very successful hospitality career, managing luxury hotels in Oahu and Maui, and helped put Alaska on the tourism map. (He has a new book.) Hospitality is in my blood.

My first vacation rental was our home in Santa Barbara, California. My wife and I would rent it out for long weekends, and later weeks at a time, as we traveled and worked remotely.

Santa Barbara gets lots of tourists, and we rented to winos 🍷 bachelorette parties (TONS of bachelorette parties), even Hollywood actors looking to escape LA for a while.

Renting our house as a holiday home was a breeze

But everything just worked. It had a name, a brand, and a personality — and we focused on the little things. Guests got a free bottle of wine upon arrival, and mints on the pillows. We had lots of repeat customers, and we were making good money.

That is, until 2015, when Santa Barbara decided to ban short-term rentals.

Ugh, devastating! More on that in a bit.

In the meantime, we tucked our tails between our legs, turned our garage into an ADU, put it on the long-term market, and moved on.

Last year, we bought and developed our second vacation rental — this time in a small Australian tourist town. I was convinced we could have the same success if we used the same methods that worked so well before. We furnished it well, took professional photos, and gave it a name.

Despite Covid’s challenges, I’m delighted to say we were able to get solid numbers in our first year. 🤘

Not a bad gross yield considering setup, upgrades, and furnishing costs

Pros

Cash flow + appreciation

If you know me, you know my favorite assets are those that produce cash flow. Like nearly all real estate, vacation rentals both appreciate and provide cash flow. You can’t control the former, but you have lots of control over the latter. You can give yourself an edge.

On a recent podcast we did, Corey Ashton Walters from Here.co said something interesting. He said one of the reasons he likes vacation rentals is that they’re priced like residential real estate, but cash flow like commercial real estate.

I’ve been thinking about this concept ever since. Residential real estate is priced in many ways, but it’s not usually priced through the lens of short-term rental yield (at least not officially).

A snapshot of the sheet I created to understand the rental market before buying. Holler if you’d like to see it, I’d be happy to share.

You don’t need much

Anything can be a rental!

Airbnb’s new “OMG” category includes everything from modern treehouses to windmills to cranes to whatever the f*ck this is.

Just this week, I discovered a company called Azure Printed Homes that manufactures 3D-printed real estate for your backyard. How cool would it be to Airbnb one of these out? (Note: They’re launching a crowdfunding campaign)

You can live in it

This is true for all residential real estate. Vacation rentals have a baseline utility that never goes away. You can live on your property if you want to. We live in ours about 20% of the time.

Immune to the 2022 downturn (so far)

With rising interest rates, I’m sure housing will start taking a beating at some point. Wyatt has been banging on about this for months.

But as of this writing, it hasn’t yet, which certainly means something.

Cons

Down payment

This can be a huge challenge given today’s prices.

I wouldn’t count on it.

But high prices have been the catalyst for a slew of innovative financing products and fractional real estate marketplaces. More on this below.

Cleaning is a pain

Rental turnover is high, and so are property management costs. This isn’t like long-term rentals, where you do a big cleanup at the end of each lease. Cleaning is a huge expense — roughly 15-20% of revenue (compared to standard long-term property management fees of around 7%)

Sure, you can do it all yourself and spend time instead of money. But who really wants that?

Appreciation risk

For investors with a short-term horizon, buying homes in markets with rapid appreciation is enticing. But there’s always a risk that prices will stop increasing, leaving you holding an overpriced bag with poor unit economics. Have fun cleaning!

If you’re a long-term investor, remember that prices generally go up in the long run. Focus on buying smart and having positive margins

The biggest unknown risk for me isn’t appreciation, but the ever-present risk that your city decides to impose a ban on short-term rentals.

Controversy and regulation

This is so big it deserves its own section.

Housing has always been at this weird intersection between a human right and an asset class — two things that are completely at odds with each other.

Let’s be clear: Airbnb takes homes off the rental market and puts them on the vacation market.

This effect can be huge. For example, New York City now has more Airbnb listings than apartments for rent.

In addition to helping jack up rent prices, it can turn previously quiet buildings into micro-party towns. While NYC isn’t exactly known for being quiet, many Airbnbs are located in suburban residential neighborhoods, whose residents (rightfully) expect quiet nights. They often complain of tourists overrunning residential areas and causing disturbances.

While they can’t stop every party from happening, Airbnb has instituted a global party ban and a rapid response team.

In many countries, real estate represents a significant portion of most people’s wealth. Homeownership is basically a cornerstone of free markets, and it has generally been politically favorable.

However, many people feel that while Airbnb is good in theory, it’s not smart to let it get out of control. Amidst the housing crisis, some even say shelter should be a right, not an asset class.

I do think Airbnb is good, even in large doses. But I also understand regulation is inevitable.

Regardless of how you feel, there are all sorts of regulations happening around the world.

🇪🇸 Barcelona, Spain

In Barcelona, many locals famously hate Airbnb with passion. In the wake of massive tourism, anti-tourism vandalism and protests were became common.

The problem got so bad that the city launched a major crackdown on illegal apartment listings. And in 2021, Barcelona became the first major city in Europe to forbid private room rentals completely.

They didn’t stop at just Airbnb: Barcelona has also prevented the construction of new hotels in the city center.

🇺🇸 New Orleans, Louisiana

In 2019, New Orleans enacted some big restrictions. They banned rentals where the owner does not live on the premises, and banned short-term rentals completely in the two most popular locations: The Garden District and (most of) the French Quarter.

But enforcing the ban has been another story. In April 2022, NOLA.com found that illegal rentals still outnumbered legal rentals by 3:1.

Opponents feel it strays too far toward an infringement on individual property rights, and feel the law would be a sledgehammer where a scalpel is needed. (This is exactly how I felt about Santa Barbara’s ban; they went too far, too fast.)

🇺🇸 Atlanta, Georgia

In March 2021, Atlanta attempted to regulate short-term rentals through an ordinance that requires hosts to pay a $150 annual permit fee, and have a copy of the property’s deed and a utility bill. Rentals are also given the same 8% tax treatment as hotels. Each violation carries a $300 fine.

I’m trying to stop the city from becoming a de facto hotel city.
City councilman Antonio Lewis

🇦🇺 Hobart, Australia

The Hobart City Council has passed the first stage of a ban on new whole-home, short-stay accommodation in the inner-city area.

We are starting a journey tonight to rebalance the use of residential homes for visitor accommodation. It’s not about picking on Airbnb, it’s about looking at a whole range of issues that affect supply but this has been an incredibly fast trend. It’s about balance.
Hobart Lord Mayor Anna Reynolds

🇮🇨 The Canary Islands

In 2018, short-term rentals were banned on the two largest & most popular islands: Tenerife and Gran Canaria.

However, the Spanish Supreme Court has overturned this ban. They noted that limiting vacation homes in tourist areas is an attempt to favor traditional accommodation products, which contradicts business freedom and violates the Law on Market Unity.

– – –

This is just a sampling of what’s happening around the world. There will be wins for some and losses for others as cities figure out what they want to be. But one thing’s for sure: these vacation rental battles will continue for many years.

Canary Islands residents are once again allowed to rent their homes on Airbnb. In fact, I’m writing this from a Tenerife Airbnb as we speak! (sadly not this one)

How to invest in vacation rentals with no down payment

The biggest blocker to buying a vacation rental is coming up with the down payment. Luckily new fractional real estate marketplaces and creative financing products are popping up to help you invest.

Here.co

Here lets you in vacation rentals like stocks. No down payment needed. Start with as little as $100 and get cash returns deposited directly into your Here account.

We know Here’s founder Corey quite well, and can vouch for their integrity. Their first properties were in Florida, and their newest property is called “Moonridge” in Big Bear, California. Check it out.

Arrived Homes

In a similar vein, Arrived lets you invest in single-family homes across the Sun Belt and the southeastern US. While not necessarily vacation rentals, they’ve sold 100+ homes and have a healthy supply of new ones each month.

Arrived’s CEO Ryan Frazier and VP of Investments, Cameron Wu were recently on our podcast:

Pacaso

Pacaso is the modern way to buy and own a holiday home.

Founded by former Zillow executives, Pacaso buys amazing single-family homes in top locations, creates an LLC for each one, and lets you co-invest with a group.

Think of Pacaso as a new timeshare model, except you actually own a slice of the home. They give buyers a flexible alternative to buying a short-term vacation rental, making it easier to both purchase & participate in the equity upside.

We’ve reached out to Pacaso a few times, and they’ve been oddly quiet on the PR front, but maybe this will change.

Their fees seem a bit high, and their financing looks a little strange (they’re using interest-only loans, which will get interesting as rates rise.) But they are getting good reviews on Trustpilot, and are looking to expand internationally.

I think the biggest benefit of Pacaso’s model could be the peace of mind. Their fee structure ensures you never have to worry about repairs or maintenance.

They also have an innovative referral equity program, which gives referral bonuses in the form of RSUs! (If this has been done before, I’ve never seen it. Pretty fascinating!)

Fund That Flip

Fund That Flip is a modern real estate lending company that takes the hassle out of financing.

If you have an existing property that you’d like to turn into a vacation rental, FTF can provide a customized loan for your project. They focus on speed and transparency, and aim to fund loans within just 2 weeks.

We recently did a profile on the company. Founder Matt Rodak was helpful and accommodating. We like their style.

Other tips for investing in vacation real estate

Look for “Tier 2” cities

Let’s face it: The prime real estate in major cities has been scooped up long ago. You’re unlikely to find many great deals in Honolulu, Sydney, Miami, or San Diego.

But Reno, Nevada is near Lake Tahoe and still quite affordable. Or what about Sedona, AZ? Or The Ozarks?

Look for smaller, up-and-coming areas that few people are talking about. Then study the touristy areas within them. AirDNA is a terrific resource.

Tier 2 cities offer the best unit economics and most upside for vacation rentals.

Look for an undersupply of hotels

A lack of existing hotel supply means opportunity, pricing power, and no hotel lobby to worry about.

“Hotels per capita” is a great north star metric to use. This database can help.

“Fewest accommodation options per tourist” is an even better metric. These guys have already done the hard work. Use their list to cheat.

Find (or create) uniqueness

What makes a great vacation rental? In the opinion of many, it’s uniqueness. Character. Something memorable that no other accommodation has.

Buying a soulless condo in Tampa and slapping an EAT sign in the kitchen won’t give you an edge. But a converted airplane? That’s much cooler.

Future historians will be baffled by verb-driven home furnishings.

Find places with year-round demand

Buying a vacation rental on Cape Cod or Lake Michigan sounds nice. These are certainly both popular tourist spots. But what do you do with the property 5 months out of the year?

Your best bet is to find places that are either permanently warm or have at least two strong seasons. Park City, Utah comes to mind. But the Jersey shore? Not so much.

In a perfect market, the weather has already been priced in. In reality, when utilization maxes out at 60%, it will be a lot harder to make the numbers work.

Consider Europe & Australia

The Euro has been strong lately, and is currently ahead of even the strong USD. So that’s a negative for buyers.

But there’s another reason to consider investing in European vacation rentals. Europeans get more vacation time than Americans. A lot more.

To me, it’s pretty simple: More time off means more time spent in holiday homes.

Australians also get a minimum of 20 days off per year, and the Australian dollar is low. Oh, and unlike New Zealand, foreigners are allowed to buy property there!

Look for places unlikely to regulate

This last one is controversial and probably impossible to calculate, but here it goes: Look for places unlikely to give two sh*ts about short-term rentals.

Santa Barbara is a tourist town, but it’s also a highly functioning city with a well-diversified economy. Santa Barbara banned short-term rentals because it didn’t want to be like Puerto Vallarta; its Mexican “sister city” is a pleasant place to visit, but has tens of thousands of “ghost units” that sit empty much of the year.

The Australian town where we bought our second place is purely a tourist town, plain and simple. It has almost no jobs outside of tourism, and is unlikely to care about regulating short-term rentals. After reading through old meeting notes from the city’s website, it was clear there there is no desire to crack down.

The thing is, you aren’t going to find this stuff out using AirDNA or any other piece of software. It’s all about doing your research, understanding economies and political situations, talking to locals, and making an informed decision.

Conclusion

As a traveler, I believe Airbnb is a great thing for the world. It gets people exploring different cities — and critically, different parts of each city. It also helps lift locals’ incomes, gives people a fantastic way to monetize what is often their biggest asset, and facilitates new relationships in a way that hotels could never do.

However, I also know firsthand that the regulatory risk is very real. Cities are figuring out what they want to be, who they want to serve, and what they want to prioritize.

Do tourists have more inalienable rights than the residents? Should cities sacrifice local wealth building in the name of keeping rents down? These are difficult questions with no easy answers. I expect cities will continue to work to ensure we have reasonable and effectively enforced regulations.

In the meantime, I love vacation rentals for the same reason I love real estate and land in general: “They ain’t making any more of it.”

It’s not a drawing of a squirrel that took 12 seconds to create (if you don’t know what I’m referencing here, consider yourself lucky). It’s not an algorithmic “stablecoin” which can drop to zero overnight. It’s as real as it gets. And over the long run it’s a source of nice, slow wealth that is nearly impossible to mess up.

But more importantly, I love vacation rentals because you have a chance to develop and improve the asset in a way that other asset classes don’t allow you to do.

This is a theme I talk about often when investing; finding your edge. What are you good at? What do you do that nobody else does? How are you going to be different?

Vacation rentals may not be right for everyone, but I know they’re right for me.

They’re right for me, because after a decade of managing them, I now feel like I truly have an edge.

Find your edge.

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Author

Stefan Von Imhof

Stefan Von Imhof

Stefan lives and breathes asset analysis and valuations. Before founding Alts, he was the Head of Product at Flippa, he created and ran Flippa's Due Diligence Program, and has bought & sold dozens of websites & newsletters. Prior to Flippa he was the first product manager at HG Insights, a market intelligence company which sold to Riverwood Capital Partners. Originally from Boston and later Santa Barbara, CA, he now lives in Australia with his wife & Boston Terrier, Charlie.

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