Vacation Rentals Are Popular But Are They Profitable? (Hint: Yes! Very.)

by | BiggerPockets.com

This is part two of a series of posts I’ll be writing about investments in vacation rentals. As I mentioned before, the vacation rental industry has rapidly evolved in recent years—largely due to advances in technology.

These changes have affected market cycles in investments in single family residential homes (SFRs). And, as it turns out, vacation rentals (VRs) can return multiples of SFRs!

Why Vacation Rentals Are Generating Large Returns

Previously I described three groups of vacation rental owners, one of which already knows the ropes—the original group of VR owners and operators. These are folks who were up and running before the crash and ensuing entry of new groups of VR owners.

The other two groups—distressed homeowners and opportunistic investors—are having to learn about owning and operating VRs on the fly. Meanwhile, the vacation rental marketplace is continuing its boom, both on the demand side and the supply side.

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The Current Vacation Rental Market

In my company’s market, when we started in 2004, there were just 14 properties listed on VRBO.com. Now the area has approximately 1,400 listings across all the VR marketing sites—the largest of which is Airbnb.

A few statistics from just the past five to 10 years are illustrative of the growth rates here. According to VRMA.org, in 2010, only one out of 10 travelers had utilized a peer-to-peer marketed accommodation (i.e., a vacation rental). But by 2015, one in four had.

Statistics from VRMB.com are equally impressive, showing that in a similar timeframe, VRs went from being almost exclusively beachfront properties to a nearly 50/50 mix of beachfront and urban properties. And this is a trend that continues.

Needless to say, this market is really taking a bite out of the hotel business. VRMB.com data also show half of the people who have tried vacation rentals now prefer them to hotels.

Yet, as of now, only 11 percent of travelers have tried vacation rentals—so there’s A LOT of growth coming. In fact, Hostfully.com reported an 8.5 percent compound annual growth rate over the past five years.

Except for a few saturated markets, most regional markets continue to enjoy demand growing faster than supply. Investors who hope to take advantage of this have choices similar to what they have enjoyed in the single family residential and small multifamily residential markets: direct investment, partnerships, and passive investments.

But direct investors and those entering partnerships indeed have a lot to learn. As such, it’s the original, seasoned operators, and a growing set of regional branded operators who are producing higher returns.

Related: 6 Steps for Successfully Investing in Vacation Rentals

Why Veteran Vacation Rental Owners Are Earning Even More

Despite the predominance of online travel agencies (such as HomeAway, Airbnb, and TripAdvisor) that make it easier for the average VR owner to list and rent their properties, it’s the experienced operators and regional brands that are leading the way with higher per-night revenues and higher occupancy.

This is largely thanks to what they’ve learned along the way about travelers and the hospitality industry that they can now apply to the VR niche. Let’s analyze some results, and examine how returns compare between regular full-time rentals and short-term rentals.

While the average return on VRs is just slightly higher than the average return on SFRs, the returns available from well-run vacation rental operators are above market. Attom Data Solutions found that the average SFR gross rental yields (gross rents/sales price) returns around 9 percent.

Compare that to your market! And keep in mind, that’s gross—not net.

Returns on SFRs are being squeezed hard in most markets today. While Attom data show that yields on rentals vary significantly from market to market, many markets are experiencing negative returns. Meanwhile, well-run VRs easily return over 20 percent cash on cash—net—before taxes.

As a passive investor, expect a secured investment in a VR to return 7 to 14 percent net before taxes, plus the tax benefits of depreciation—and not counting appreciation over time. Actual returns in a passive scenario will depend on whether you wanted regular and predictable cash returns or were willing to simply participate in the profits on a quarterly basis (including seasonal swings).

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Related: 13 Mistakes New Vacation Rental Owners Always Make

The Math Behind the Returns

Here’s an example to illustrate how vacation rentals can produce better returns.

An SFR property might cost $250,000 to purchase and provide monthly rentals in the range of $900 to $1,200 per month.

A VR property might cost as much as $325,000 but produce rents in the range of $250 to $400 per night.

Our operating model calls for our properties to cover the entire cost of operation with four- to six-nights occupied per month—and more occupancy obviously produces greater profits. Even for highly seasonal locations, which produce 13 to 15 nights’ occupancy on average, monthly revenue sits around $4,000 to $6,000 per month.

It’s this dynamic that can produce much higher returns for similar properties. Of course, there’s a catch though. And it’s something you may have already suspected.

Managing VRs is NOT the same as managing full-time rentals. Operating a vacation rental such that occupancy and nightly rates are kept high to enable high returns requires experience and a team. While this isn’t different than investing in SFRs or fix and flips, the skill sets and the players on the team do differ.

Today, you see some SFR investors trying a new dodge. They find a property the same as they always did, but now they analyze it as if it were a VR, looking for what they need and analyzing for cap rate or cash on cash return. This is a formula for overpaying for a property. It’s also a formula for purchasing properties in the wrong locations or properties that just aren’t suited to be vacation rentals.

Think about it. Imagine you are wanting to go on vacation and want the extra space of a vacation rental or a full kitchen. Will any house in any neighborhood be what you are looking for? Nope.

You wouldn’t throw a dart at a map to pick where you were going to stay while on vacation, but that’s essentially what happens when somebody looks for houses the wrong way.

If you’ve been successful with flips, full-time rentals, or small multifamily properties, you had to learn a lot along the way. Expect to have to do that again if you want the superior returns you can get with vacation rentals.

Therefore, if you are looking to invest passively, seek out an experienced operator to invest with, one who knows how to source and operate the right kinds of properties.

What other questions do you have about vacation rentals and their potential returns? Are you currently participating in the VR niche or are you hesitant to dive in?

Let’s discuss in the comments. 

 

About Author

Stephen Sorenson

Steve Sorenson is a vacation rental property developer, creating and operating superior vacation rental properties under the regional brand of Classy Cabins AZ,the family business having been founded in 2003. He is also the principal of VRI Management LLC, the funding arm of Classy Cabins AZ. A contributor at Bigger Pockets, he also writes for his own websites and others such as WhiteCoatInvestor, spreading knowledge gained over 16 years as an active real estate developer and investor. Since 2003, he and his wife have used the business to educate their children while creating superior properties from the ground up by carefully choosing their sites, designing, decorating and operating their properties specifically as vacation rentals. With five superior properties under management and three more under development, they've begun branching into re-development of urban properties as well. Along the way Mr. Sorenson has fixed and flipped, and employed the BRRRR method as well, investing in single family housing in addition to vacation rentals. Visit us at Classy Cabins AZ to see the sort of properties we develop. Mr. Sorenson also posts information and articles at VRI Management LLC's site.

9 Comments

  1. Chris Mylan

    Thanks for the articles, Stephen. Looking forward to reading part three and beyond. You may be doing this in another post, but I think it’s important to dig into the expenses as well (not just the gross/ net income). As an owner/ operator of a couple STRs in the DC area, I was surprised when I started out to the extent taxes, paid cleaners, initial furnishing, messaging guests/ constantly putting out fires (time), etc. effect one’s bottom line. The numbers still suggest it’s a more profitable investment than SFH, but folks should definitely be aware of those factors and expenses.

    • Stephen Sorenson

      Hi Chris,
      You are absolutely correct – and this is where you find the difference between real profitability, and just getting by. As mentioned in the article, we have a model where we design, build, equip and finance such that we expect to get all of our fixed costs covered with 5 days per month in rentals. The variable costs are essentially a passthrough such as cleaning and insurance. This leaves the costs that are neither the fixed or the variable – maintenance, repairs, supplies, utilities. We have a bit of an advantage in our cost model in that we are essentially getting in at wholesale. Since we build from the ground up, we have an initial cost advantage. There IS a lot of work in Vacation Rentals, though if your cost structures are good, you can outsource nearly all of it. To circle back, since we are doing a good job of marketing the properties, we far exceed our break-even despite the seasonality of the business. In our local market, we can’t find a way to make returns that are close in SFRs today.

  2. Katie Rogers

    Expenses are also considerably higher. Our vacation rental covers its PITI, all operating expenses and taxes, including business license and transient taxes, and the full-time support of the on-site caretaker (in a detached apartment on the grounds). Not much more though.

  3. James McCreary

    Great article Stephen, everyone used to always say this but you were able to make a case. I thoroughly enjoyed reading it.

    I’d have to echo the expense comment. With this much more “wiggle room” the diaprity between amateur, “hands-off” operators and business owners fully invested in this is only made more disparate in terms of operational efficiency (there are merits to both approaches, don’t get me wrong).

    Looking forward to further wisdom and seeing how the dynamic market place affects (or doesn’t!) your strategy.

  4. Edward Briley

    I am someone that has flipped SFH’s, and I have looked into buying vacation rentals. After talking to many owners that invested into vacation rentals, I have been drawn to the conclusion, in my case it is not worth the time or effort. Is there money to be made in buying vacation rentals? Of course there is, but there is money more easily made making other investments.
    The best advice I have been given is to look in your own back yard to buy a vacation rental. I mean within a few miles from your own home. Even an hour away from your own home is too far away in most cases.
    I live in a town in which is an hour away from a major vacation area. Many people in the town in which I live own a vacation home or condo in the vacation area. You would think they would be making thousands of dollars a month on those properties? The truth is that they have even figured out the time and the money to rent these units out is not worth the time or the effort to do so. Some of these people pay more than $5,000 dollars a year in property taxes for their rentals to sit empty – not to mention utility cost etc… They will not sell them for various reasons, and the main reason is that it is their vacation home and they can afford it.
    Now I want you to sit down and do the numbers and think? First of all, you need to realize that there is only 26 weeks a year in which you have a mass number of people looking for a place for vacation. Now, your rental time in those are basically 13 weeks a year. Even at renting the properties for the 13 weeks, you have repairs to do between occupancy. And while they are occupied, people expect one cleaning during their rental week. (Sheets, towels, etc…) Either you the owner has to do this, or you need to hire someone to do it. Now speaking some of the owners of these properties, that if you do not have a square footage large enough to sleep 6 to 8 people, they are not in that big of demand. Now on the good side, if you do, a Saturday to Saturday rental in this area is up to $2,000 dollars per week, some more. Now with that being said, the cost for cleaning and maintenance quickly multiplies. Now to get the $2,000 per week, you are going to need to have nice appliances and the unit has to be kept up to modern standards.
    Now the $26,000 dollars a year looks good and very profitable. But remember, you more than likely have a mortgage on the property that has to be paid every month. In a resort area in high demand, that mortgage and with a condo add an HOA fee. (Truthfully a condo with an HOA fee is the best deal, because that pays for the upkeep on the exterior of the property, real-state taxes and most HOA fees in vacation areas pay for most utilities and even cable TV).
    Now with the above being said, truthfully a vacation rental can only be priced on what is able to be made in the off season. For instance if you can only get $1,000 dollars per month by renting it in the off season, your mortgage with the HOA fee should not be more than the $1,000 dollars per month. You need to also realize supply and demand in the off season. Someone has to pay the mortgage and HOA fees in the off season. Many investors lose their properties because they are not able to do so.
    I used $26,000 dollars, because even though you are able to rent your property out more than the 13 weeks, your income totals are not very likely to exceed that number if you are not within a few miles of your investment property. I am going to make another comment on this, please look for it.

  5. Edward Briley

    I now live in Plymouth, NC. I keep my account in the Tidewater area, because I still own property there. I moved here because I retired.
    Now, for all of you that want to know were to invest in VR’s I highly suggest you do it in small town USA. You can do it, and do it cheap. Matter of fact, if you want to start a business, with the Internet you can be highly successful.
    Now, VR’s in small town USA. The town in which I live is one hour from the Outer Banks of North Carolina. At least 1 percent of the population here owns a vacation property in the Outer Banks. I do not know one of them that rents out their VR, unless they own an entire resort there. Plymouth is on one the 3 West to East highway to get to the Outer Banks and sits just 15 minutes away from Highway 17 witch is the N to S scenic highway.
    Pretty much our downtown area is dead. What makes this really sad, is that half of the retail buildings set right on the Roanoke River. Many have a boat dock also. And guess what, many of them are for sale. For far less than $250,000 these buildings can be bought, upgraded with 4 studio apartments in them, that could be rented on a home away type website for $500 per week, or even $500 per month during off season.
    Now, to own one of these buildings that at least 50% percent of the ground floor has to be retail.
    That is no less another $500 per month you could get, or you could operate your own small business in it. Many of these circa 1900 buildings can be purchased for well under $50,000 dollars, and that may include the old movie theater?
    Plymouth has pretty much all of the Fast Food franchises, (Sorry No Hardees or Chick-fil-a at this time, but you could open one here) and two large grocery retailers. Pretty much everything you could expect in a big city, however, the Wally World is 20 miles away. The town population sets at 3,500.
    I bought a 2,800 sq ft foreclosed home here in 2015 for $47,500 that I can now easily sell for $125,000. Invest in Plymouth, and you will get a larger return than you could expect anywhere.
    Do a web search for “Plymouth, NC” and see for yourself.

    • Katie Rogers

      Not just any Small Town, USA will work. There has to be something that appeals to tourists fairly close to the vacation home. In my experience with small towns, if there is no job growth, there is no demand for apartments. A dead downtown suggests lack of job growth.

  6. Jerry W.

    I have a small VR in a town of about 2800 now. The first year was really rough, but we didn’t get it opened until after tourist season. The next year we probably made a bit less than a regular rental makes, but it was a LOT more work. This year is stacking up to be a pretty good year. We also got the second side of the duplex fixed up and ready to rent. It is my hope that having the second VR next door will not be twice as much work hehe. I also added AIR B&B to just VRBO, but keeping both calendars updated takes a little work. This will be the season to see if we are really making anymore money than a regular long term rental or not. I am surprised at how much I enjoyed fixing up and furnishing and even renting the VR. Time will tell if it continues to be fun. Our tourist season is not that long, 4 months maybe 5, and it not nearly as high as destination areas. Lots of folks pass through to go to Yellowstone National Park, or the Tetons, or even Cody WY, but many stop for a day or 2 to enjoy our hot Springs. Even small towns can do well, but be ready for very slow off seasons.

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