Law of Diminishing Returns on STR's?

Question

Hey BP fam,

I currently own and operate several STR's but they are all in the same price point. I am helping a client who is looking to be at a much higher price point. We have a certain amount of capital to deploy in order to maximize total revenue. The question here is, does he buy 1 larger more expensive property (let's say $1.5M x 1) or split it up and buy 2 smaller properties ($750,000 x 2) or even 3 or more smaller than that ($500,000 x 3).

Obviously there is more work involved with setting up multiple properties, but I suspect the returns will be higher on smaller properties. I don't have data to put to my theory, but I believe there are diminishing returns with ever higher price points (hypothetical graph below).

Does anyone have any data on this or can confirm? Of course, tons of nuance here, but just in general.

Thank you!

James Carlson · Answer

I love this question.

I see a point of diminishing returns for Airbnb properties here in Colorado. Of course it's market-specific, but I see a drop off in viability for most submarkets here around $1.5M in price. Or I should say, I don't see making any kind of money beyond that.

My super rough screening method for properties is a revenue-to-price ratio of 10%. (And that's sometimes too low, still.) Reverse-engineering that then, are there any properties making more than $150k/yr? Not many right now. So that $1.5M makes sense here as the upper most.

I also just looked at my most recent successful STR investors here in Colorado. They bought homes that cost somewhere between 25-35% over the median price in that area, but no more. So ... I don't know. Different ways to look at this.

Bill B. · Answer

I would assume they operate along the same lines as LTRs. The more expensive the lower the returns. Cheaper properties “always” have higher returns. Otherwise why would anyone have cheaper properties?

if I could have one $6M property and make the same or more than my twelve $500k properties, I’d make the swap tomorrow. But everyone draws a “work for returns” line. I could probably make more with twenty four $250k properties. But I’d want to make 50-100% more for the extra work. Plus you’d give up some appreciation. (They can’t be both cheap and quickly appreciating.). You also run in to the problem with cheaper properties that many repairs cost the same as they do for properties worth twice as much with double the rent.  So there’s a “Goldilocks” zone where returns are decent but capex/repairs don’t kill you.

Ian Tyndall · Answer

I think it is linear and scales with the purchase price.

I tend to hear that luxury properties are more in demand and insulated from market fluctuations better than lower range properties. If the returns are all relative, I would go with a single property to minimize management complexity. There are some risk trade offs like “all eggs in one basket” versus fewer turnovers and guest liabilities and consumables. My personal advice would be to focus on the highest end of the range that is affordable

Andrew Steffens · Answer

Speaking from the POV of a PM and broker in the Tampa market:

The returns are not linear and there also is not a rule.  I could not tell you a $500k will generate 12% CoC and a $750k property will generate 18% CoC.  What I can tell you is typically $300-400k is the entry level into SFR STR's and since it is the lowest bar to clear there is more supply in this category leading to price competition and lower returns.  Going up to the $500-700 rung gets you a bigger house with more amenties and naturally a higher return.  The best returns I see are usually $700-$1M.  Much lower competition and really beautiful properties generally produce the best results.  Above $1M or so you start to see diminishing returns.

As far as answering your questions, if it were my market I would likely buy 2 properties to spead risk primarily.  In my market there are 2 submarkets, one being the beaches and the other being Tampa proper.  If you bought 1 in each you could hedge risk a bit while still having good returns on 2 properties.

Good luck!

Michael Baum · Answer

So @Samuel Boyd, I look at things this way.

A single high end property will do X amount of dollars. That could be more than 3 more modest properties or maybe not.

What I believe to be true is that the market for a single high end property will be smaller than 3 more modest ones.

Most folks can't afford a $2000 a night place (or whatever that might be) but most families can afford $400 or $500 a night for a nice place that fits the bill.

Like @Patricia Andriolo-Bull said, more data is needed to really drill down. I think in most markets, 3 nicely appointed modest properties will perform over the long run better than a big fancy one.

If I had my choice, I would have 3 lake houses like I have now rather than a single lake mansion. I know I could keep all 3 booked solid for the season whereas that big house, I am not so sure.

Patricia Andriolo-Bull · Answer

Many more details are needed to answer this question. In my market, smaller properties on the water have a higher return than larger more expensive properities. It is property and market specific and you would have to run the numbers for both.

John Underwood · Answer

I would do the one high end property that could demand top dollar. Less work to manage one.

I heard a respected STR person say if she could go back in time, she would have less small properties and would have owned less properties, but bigger nicer properties.

Jon Martin · Answer

Assuming the quality location is the same for all options and purchase prices listed above, I would go for the single property so long as there were comps hitting the 20% rule (rev/pp). If there were better ratios with 2 smaller properties that were half the price, then great go with that, but that's usually not the case. Revenue tends to keep scaling up with bigger and nicer, people book further in advance, and it's easier to justify 3+ night minimums.

Hunter Foote · Answer

Interesting question. I’ve run into a similar debate in my own investing, though in a different niche (sober living instead of STRs). What I’ve noticed is that the returns don’t always scale proportionally with price, and there definitely seems to be a “sweet spot” where demand, occupancy, and operational risk all balance out. Go too high and you risk sitting on a property that looks good on paper but underperforms in reality; go too low and the extra management or turnover can eat into returns.

I like @James Carlson's rule of thumb around revenue-to-price ratios. For me, I tend to reverse-engineer the deal the same way: what’s the actual achievable income in that market, and does it justify the price point? That often tells you whether to go with one larger asset or multiple smaller ones.

Curious what others here think: in your markets, where have you seen the “cutoff” where returns flatten out? Is it more about property type, or more about the local demand drivers?

Ryan Moyer · Answer

Bingo.

Average is death right now in the STR space.

Law of Diminishing Returns on STR's?

Most Popular Reply