Short term rental on primary residence?

Question

My husband and I live on a 20-acre property about two hours northwest of Minneapolis in Minnesota’s lakes country (not directly on a lake, but surrounded by plenty of recreation). We built our forever home in 2019 and are just starting to explore real estate investing.

We both have W-2 jobs, have young children, and are trying to be intentional about how we get started. Rather than jumping into a flip or BRRR right away, we’re considering building a small short-term rental cabin on our property. The cabin would be located on a separate 2-3 acre parcel with its own private driveway, wooded setting, and walking trails, so guests would have privacy from our primary residence.

Our biggest question is about financing.

We purchased our land outright with cash before building our home, so while we have a mortgage on the house, we own the land itself free and clear. If we were to subdivide a 2-3 acre parcel for the cabin, would we potentially be able to use the equity in that land as our down payment (or equity contribution) for a conventional construction loan?

A few additional details:

• • Our estimated cabin budget is around $125,000.
• My husband is a skilled tradesman who could complete much of the construction himself, helping keep costs down.
• • We like the flexibility of this project because if the short-term rental market didn’t perform as expected, we could convert it to a mid-term or long-term rental, or ultimately sell it if necessary (although that’s not our preferred exit strategy).

Our long-term goal is to use this first project to build equity and cash flow that we can eventually roll into additional properties.

For those who have built STRs on their own land or financed a similar project:

• • Does this seem like a reasonable first investment?
• • Are there financing options or pitfalls we should be aware of?
• • Is there anything you wish you had known before taking on a project like this?

I’d really appreciate any advice or experiences you’re willing to share.

Thanks!

Adam Tafel · Answer

I would focus on the ARV and total project cost. The bigger the margin the safer the deal. Will people want to rent an STR not on the water? What about the winter? It’s pretty tough to make an STR work even on a MN lake at today’s pricing, lots of vacancy.

Devin Cable · Answer

Hi Kendra, I'll start by saying that this is absolutely a reasonable first investment. Building a rental on land you already own is one of the lower risk ways to get started. There are a couple things I believe are worth mentioning... there may be another path forward worth considering. Path 1, subdivide. You carve off the 2-to-3-acre parcel and build on its own lot. The upside is the cabin becomes its own property you could sell separately someday. The catch is your existing home mortgage almost certainly blankets the whole original parcel, so you'd need a partial release from your current lender plus a clean legal subdivision with its own tax ID. That tends to be the real hurdle, more than the construction financing itself and can turn into a several month holding period. Path 2, build it as an ADU. Instead of splitting the land, you build the cabin as an accessory dwelling unit on your existing property. This skips the subdivision entirely, no partial release, no separate parcel, it all stays under one roof financing-wise. The tradeoff is you couldn't sell the cabin on its own down the road, but since that's not your preferred exit anyway, it may be the cleaner route. You'd just want to confirm your county and township allow an ADU and allow it to be used as a short-term rental, since those local rules vary.On using your equity. The good news either way is that you own the land free and clear, and that equity can function as the funding source for the build rather than you bringing a big pile of cash. There are a few ways to structure that depending on which path you take.One pitfall to plan for. Your husband doing much of the work is great for cost, but a lot of lenders won't let an unlicensed owner act as the general contractor. Us lenders almost always have to approve and vet your general contractor before funding, meaning we review the builder's license, insurance, financial stability, and track record to make sure they can actually complete the project on budget.I have an idea I think would be worthwhile exploring with you. I am going to send over an invite to connect if you'd like to discuss.

Kendra Fearing · Answer

That is a great point. We will look into this! Thank you.

Marc Winter · Answer

@Kendra Fearing,

What a great idea!

However, before you dive further into it, I have a question for you, which must be answered--  A house is generally considered an improvement to the land. You usually cannot separate the two for mortgage collateral unless the property has been legally subdivided and the lender’s mortgage only covers one specific parcel.

It's understood that you bought the land without a mortgage, and only financed the building.  In my experience, the lender will have attached that lien to the property as well.

So, while you may have paid cash for the land originally, that doesn't mean the land is still free and clear after your original construction/long-term financing.

The mortgage on the home almost certainly attaches to the land under the house, and possibly (probably) the entire original parcel. You need to check the mortgage/legal description and title, not rely on memory.

My thought on best resolution:  subdivide -- carve out the 2 or 3 acres, and build the str on that plot.

Good luck--let us know how this turns out!