What you should know about STR Real Estate

Ever since many pandemic travel restrictions were lifted, the short-term rental (STR) real estate market has been on a tear. According to the STR data research firm AirDNA, revenue from STRs listed full time hit an all-time high last year, and guest demand for STR real estate is projected to grow by more than 14% in 2022.

If you’ve been thinking about getting into the business, now just might be the perfect time. In this article, we’ll take a closer look at how STR real estate works, important things to know before investing in STR property, and where to find STR real estate in some of the best markets today.

Key takeaways

STR is generally rented for less than 31 days to the same tenant.

Advantages to owning STR real estate often include higher annual gross rental incomes and more flexible use of the property because guests only stay for a few days at a time.

Although STRs have higher operating expenses, annual returns from STR real estate can be the same or more compared to a property rented in the long term.

What is STR real estate?

STR real estate is generally defined as property that is rented for fewer than 31 days to the same tenant.

Examples of STR real estate include:

• Vacation rental homes listed full time, such as an Airbnb business
• Second homes that are rented out part of the time
• A spare bedroom rented out of a primary residence, known as house hacking

STR vs. LTR real estate investing

Long-term rentals (LTRs) and STRs are the most common ways to directly invest in real estate, and both have distinct advantages and disadvantages. Here are some of the similarities and differences between owning and operating STRs vs. LTRs.

Income stream

The rental income from an LTR is generally more predictable because tenants normally lease for 12 months at a time. If a home rents for $1,000 per month, a landlord can reasonably expect to receive $12,000 in gross annual income, unless there is a problem with the tenant. Knowing what the income stream is likely to be makes it easier to budget for expenses, anticipate cash flow, and qualify for financing.

On the other hand, the income stream from STR real estate can be inconsistent and affected by factors such as the average daily rate (ADR), the average stay of each guest booking, competition from nearby resorts and hotels, and seasonality.

However, the gross income stream from STR real estate also can be greater. According to AirDNA, an STR analytics provider, the average annual revenue earned by STRs listed full time reached a record level of $56,000 in 2021.

Tenant turnover

Renters of STR properties frequently come and go, with an average length of stay (ALOS) of between 6 and 7 nights per booking. In order to generate a consistent income stream, an STR property owner needs to constantly be marketing the property for the next guest booking.

By comparison, a landlord with an LTR can normally expect a tenant to turn over no faster than every 12 months, and even longer if the tenant renews their lease for another year.

Operating expenses

STRs and LTRs have similar expenses, such as property management and leasing, property taxes and insurance, homeowner association (HOA) fees, and a mortgage payment if the property is financed. In most cases, utilities in an LTR are paid directly by the tenant or included in the monthly rent if a multifamily property has a master meter for a utility such as water or gas.

But there are additional operating expenses to plan for with STR real estate. Because tenants turn over more often, the maintenance and repair costs will be higher due to more frequent repairs and cleaning. An STR landlord also is responsible for keeping a home fully furnished and decorated, replacing towels and linens as they wear out, restocking kitchen and bathroom supplies, and directly paying for all utilities.

So, even though the gross rental income from STR real estate can be significantly higher than an LTR, the total cost of owning and operating an STR is much greater.

However, even though operating costs are higher with an STR property, potential returns can be the same or greater compared to LTRs. For example, some of the homes listed for sale on the Roofstock STR Marketplace offer potential gross yields comparable to LTR properties.

Financing options

Lenders like predictability, which is one reason loan terms for STRs are different from LTRs.

Because a property rented out to a long-term tenant has consistent income, operating expenses and the mortgage can usually be paid using the incoming cash flow. Traditional financing options for an LTR generally offer competitive interest rates and require a down payment of about 25% of the property purchase price.

When it comes to financing STR real estate, traditional or conventional loans can sometimes be difficult to obtain due to restrictive lending requirements. According to the How to Finance Your Vacation Rental post on the AirDNA blog, types of STR loans available include:

• Asset-based loans evaluated based on the actual or potential income from an STR, rather than a borrower’s income and debt-to-income (DTI) ratio
• Home equity lines of credit (HELOCs) that access accrued equity in a primary residence to use toward the purchase of an STR
• Cash-out refinance of a primary residence or another investment property to raise funds to purchase an STR

Exit strategies

An investor who wants to sell an LTR with a tenant in place is limited to selling to another LTR investor, unless the tenant can be convinced to leave. To be sure, selling a home with a tenant in place isn’t a drawback.

As the Arbor Q4 2021 Single-Family Rental Investment Trends Report notes, cap rates for SFRs dipped to 5.5%, hitting an all-time low. Declining cap rates, also known as “cap rate compression,” occur when property prices increase relative to the stream of net operating income generated. In other words, investors are willing to pay more for less income.

However, an investor with STR real estate can have the best of all worlds by choosing the most profitable exit strategy when the time comes to sell.

Because an STR property isn’t tied up with a tenant on a long-term lease, an owner can more quickly respond to changing market conditions by selling the home to an investor looking for an STR, an LTR, or to an owner-occupant looking for a primary residence.

--Jeff Rohde (Roofstock)