Why Short-Term Rentals Work Better for House Hacking
Over the years, I’ve discovered that in real estate investing, many things that are true seem counterintuitive. I often tell you guys to zag when everyone is zigging. This is not just a fun-sounding cliche. It is truly necessary to succeed in business.
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For instance, to many of you, the hypothesis I pose in the title of this blog post may seem ridiculous. And yet, the truth is very likely the opposite of what you may think. My thesis is that using short-term rentals in your house hack is much better than long-term rentals for many reasons. Because of this, I use short-term rentals in my own luxury house hack.
In order for this conversation to make sense, we must identify certain key elements. At the core of any house hacking endeavor is a desire to make money; that’s the essential truth. However, making money doesn’t happen in a vacuum. Making money in any enterprise is associated with some amount of risk and time commitment.
Therefore, it’s reasonable to conceive any money-making opportunity is a synergy of income (or wealth) generation potential, risk level, and time commitment. In other words, there exists a golden mean whereby we can make the most financial gain with the least amount of risk and time commitment. And house hacking is no different.
If I were to say (which I am) that it is a much better idea to use vacation rentals in your house hack, what I want you to read is: Using vacation rentals in a house hack will generate the most financial gain with the least adjusted-to-gain risk and the lowest adjusted-to-gain time commitment. We won’t be able to explore the minutia here, but let’s see if we can get a bird’s eye view.
Stability of Income
It is obviously paramount in a house hacking situation that the income be stable. Income stability, presumably, is the whole reason you are doing a house hack in the first place. And in this category, it would seem that long-term rentals win out. After all, you place a tenant on a 12-month lease, and you can rest assured that the money will come in. However, while this scenario may or may not be the most stable, it certainly is not the one that makes the most money.
Have you ever heard of an economic principle called velocity of money (VOM)? Just to paint the picture very quickly for you, what happened in the Great Recession is that money stopped flowing through the economy. We live in a debt economy, where credit is akin to oil in your internal combustion engine. If the oil stops flowing, the engine seizes up. In much the same way, should credit stop flowing, the economy will freeze. Why? Because buyers can’t borrow money to buy stuff—and sellers, therefore, can’t find anyone to sell to.
VOM measures the transactional speed of money flowing through the economy. During the Great Recession, VOM froze up. This is never a good thing. However, as it relates to your house hack, the reverse is true: The faster the velocity of money (think money flowing to and through you), the more money-making potential the strategy has.
Well, on a 12-month lease, you are going to get paid once per month. In a vacation rental situation, I am getting paid three to six times per month. This is why in lieu of making $600 per month, I am making $1,000 to $1,800 per month, with an underwritten average of $1,300—which I am out-performing so far.
So, what do you want—and what’s more important to you? Making more money, or making less but more predictably? This is the surface-level argument. The reason I say “surface-level” is because it presumes that a 12-month lease (while producing less income) will indeed be more stable. But try a zagging mentality in a world of ziggers, and you’ll see this is not necessarily true. We’ll touch on this below.
Do You Want Renters Living Next Door?
First, let me ask you: Have you ever evicted a tenant? I might suggest that until you’ve experienced all of the colorful behaviors tenants engage in when under stress, perhaps you shouldn’t jump to assume that having them next door to you and your family will be a great thing.
You see, if you’ve signed a lease and then don’t like them, or if they turn out to be bad tenants, you’ll have to go through the process of evicting them. And of course you’d have used a lease if you thought, I want stable income so I need a 12-month lease. But are you sure that the best solution for a house hack is a circumstance where you might find yourself knocking on your neighbor’s door to tell them they have three days to get out? At this point, you’ve presumably lived next door to this person or family for months. You may have become friendly—or even friends. How much will you enjoy evicting them?
Is a 12-Month Lease Really More Stable?
Ever since you first read Rich Dad, Poor Dad you’ve been privy to the notion of diversified revenue streams. You’ve been reading all about how a single W-2 income is not safe or stable because it’s only one source—if anything happens to it you’ll be in trouble. You read those ideas and you couldn’t help but to nod your head in accord.
You logged onto BiggerPockets with the intention of learning how to use real estate to diversify your income and get off the W-2 train. You listened to Brandon’s webinars and learned that multifamily renting is great, specifically because by its very design, it both focuses your investment and diversifies revenues at the same time. You also heard (from Brandon—man, that guy gets around!) that perhaps the best way to jump into the real estate investing game is to try a house hack. So you decided, yep, house hacking it is!
But being the smart puppy that you are, you decided that the best way to house hack is with a multifamily unit. For the same reason you don’t think your W-2 is safe, you don’t believe having only one rental unit is safe. Like I said, smart puppy! So, you started looking for a triplex or fourplex so that aside from the unit you’ll be living in, there will be more than one other unit left to rent. Diversified revenue streams is a good thing. Smart!
Unfortunately, it won’t take long for you to figure out that this approach puts you in a tiny, 700-square-foot, two-bedroom, one-bathroom unit in a rather so-so part of town, dealing with two or three tenants who struggle to pay rent every time the alternator in their car breaks. You won’t really want the 700-square-foot unit nor the tenants that come with this place.
“Oh shucks,” you’ll say to yourself. “I guess house hacking is for 20-somethings. I can’t do this.”
And you’ll be right!
But if getting paid more than once every month (diversifying your revenue) is your goal, you can have it. Luxury house hacking puts you in locations where you’ll not only want to live, but many people will also want to visit for both business and pleasure. Because of this, instead of having three tenants who pay once per month (on the months when they can afford to), you can host three short-term guests who pay you three times per month via an automated process executed by a third party.
In this setting, getting paid more than once per month not only makes more money due to heightened VOM, but it also decreases the risk of loss of income! And now, you will be living not in a crappy fourplex in a so-so location, but in a class-A area with upscale construction. Talk about killing three birds with one shot!
But we’re not done yet!
Why Is Luxury House Hacking Better?
Well, if I’ve been able to cause you to think about diversification of income and VOM, then the next obvious question to ask yourself is, “How do I attract the most stable short-term rental income?”
This is an involved and multifaceted conversation (and to get the whole scope, it’s likely best to just read my book), but in short, you want to deal with people who have money! You don’t want to deal with people who can only afford $20 per night for one night. You want to deal with people who are willing to pay $250 per night for a quality room but will happily take your equally nice place at a discounted rate. Why? Because these people care about their credit, which makes them easier to manage.
What type of property are these people attracted to? Think luxury! They can afford it. They expect it. And they will get it.
What type of people are easier to manage? Those who can afford an apartment in a so-so location (most months)? Or those who care about their credit and have money to spend on trips?
Hopefully the above sheds light on why I chose to do a luxury house hack, and why I think it’s the best option for most people above age 30. Not only will it improve your lifestyle thanks to better location and asset quality, but it will provide for the most stable income with the least risk. And we haven’t even touched on appreciation, CapEx exposure, repair and maintenance exposure, economic losses, and all the rest.
This is the way I see things at least, but it does involve a bit of zagging.
Has zagging brought you financial success? How so?
I want to hear about it! Drop me a line in the comments section below.