How to buy a vacation rental properties in 5 easy steps
https://fitsmallbusiness.com/author/mpattersonfitsmallbusiness-com/
WRITTEN BY:Melanie Patterson
Published April 30, 2020
Melanie is a certified business advisor with over 25 years of experience in real estate investing. Her expertise is highlighted throughout Fit Small Business’s real estate financing, property management, and real estate investing content.
Have you ever dreamed of owning a beachfront home or small cottage in the mountains that you can use for your vacations and rent it out when you’re not there, leveraging other people’s money to offset property expenses? I owned a cottage on a secluded lake for 12 years and did just that. I could easily offset expenses without having to rent it frequently. Here, we’re going to give you five steps to help you buy a vacation rental property for fun and profit.
If you want to buy a rent-ready vacation property with a property management company in place, consider investing in turnkey real estate through Roofstock. With Roofstock, you can browse properties that come with existing tenants and property managers in around 40 different rental markets. This allows you to find the property that’s right for you and start receiving rental income immediately.
1. Choose an Appealing Vacation Location
People buy vacation properties to use as a second home or to bring in rental income that offsets some of the costs of ownership. Some investors specialize in vacation rentals and build real estate portfolios consisting exclusively of vacation rental properties. When buying a vacation investment property, it’s important to choose a location that is appealing to renters—near the coast, on a lakefront, or in popular travel destinations, for example.
The best locations are near attractions such as beaches, mountains, lakes, casinos, or a state or national park. Location, amenities, and attractions are important when considering where to buy a vacation rental property. Choose a vacation rental property in an area you like but also consider how renters will access and enjoy the rental property too.
Where to Find Vacation Rental Properties
An online search is the most convenient way to find vacation rental properties. You may already have an idea of where you want to own a vacation property. Sometimes, you can find great properties right in your neighborhood or state. Having proximity makes self-managing a vacation rental easier than if you live far away.
Consider your budget. Areas with high tourism tend to come with high property values, but they also generate higher rental income. It doesn’t mean you have to give up that location. Maybe you can find something in a surrounding town or on the outskirts if you can’t afford property in the higher-priced area.
You also can call a local real estate agent to work with you in finding a vacation rental.
2. Calculate Income & Expenses
Once you identify a potential property, you need to make sure you can afford it, even when it’s vacant. Look at what vacation rentals in the area go for and compare this to your monthly financing and operational costs. If you can get an idea of occupancy rates for a vacation rental in that location, it will help you calculate income. Local property managers and real estate agents can help you find this information.
Example: If a property’s monthly operational expenses are $250, mortgage, taxes, and insurance are $1,750, and the nightly rental rate is $100, with an occupancy rate of 80%, you can calculate your potential monthly profit in the following way:
Potential monthly income: [($100) x (80%) x (30 days) – [($250) + ($1,750)]] = $400
In this example, the property is cash positive if it was rented a full 30 days in most months.
However, you reduce your occupancy rates and income if you live in the rental part-time. The occupancy rates and amount of collected rent also decline during off-peak seasons, so you’ll need to test several scenarios to make sure the property is bringing in the income you desire.
Let’s cover some of the expenses you may encounter so you can calculate the cost.
Vacation Rental Property Expenses
Besides mortgage and insurance payments, you’ll also have to pay for online booking fees for your rentals, taxes, insurance, homeowner association (HOA) fees, utilities, repairs, and maintenance. You may also have to pay extra to advertise for renters. If you outsource to a property manager, you’ll need to include those fees, but they generally absorb your advertising costs as part of your management contract and fees.
Taxes on Vacation Rentals
Property taxes: These are typically tax-deductible. Consult your certified public accountant (CPA) to take advantage of the most tax deductions available for a vacation rental. You can find property tax information online, usually on the property’s listing, or through the assessor’s online database.
Rental income taxes: You’ll pay these at the end of the year, but only if you rent the property for more than 14 days. Anything less, and you won’t have to pay taxes. If you do have to pay taxes, you will be taxed on your rental income based on your ordinary tax rate.
Occupancy taxes: Also known as a hotel or lodging tax, these generally range from 5% to 19% per night, depending on your state. Vacation rental landlords typically charge these taxes to their guests. These may be in addition to state lodging taxes. If you rent your property through Airbnb, it may collect the taxes for you if your city has signed up with them to do that.
Property Insurance
Make sure you have the right homeowners policy for your type of property and how you plan to use it. A regular second home policy may not cover you if a renter gets hurt or damages the property. You will need either a homeowner’s or landlord insurance policy based on use and occupancy. The type of insurance you need depends on how often you will rent the property and how often you will use it yourself. Inquire about flood insurance if you are in a flood zone.
HOA Fees
If you purchase a condo or a home in a planned community with common areas, you will be responsible for paying HOA fees. These fees vary based on property type, size, location, and amenities. HOA fees are usually paid monthly but can also be paid quarterly. If you rent the property the fees can be tax-deductible.
Utilities
Include expenses for heating, cooling, electricity, and gas for cooking. Before buying property, you can get a general idea of these costs from the seller and local utility companies. The costs will vary depending on how you and your guests use the property.
Management Fees
Some vacation rental property owners hire a property manager if the property is far from their primary residence. These fees vary based on the services provided by the management company. Average fees are 28% of the vacation rental income. They’re higher than the average fees of 4% to 10% for long-term rentals because the rental income is sporadic or seasonal, and the property management company has more work to do with more frequent tenant turnover, so expenses are higher.
Financing Costs
If you finance your vacation investment property, you need to include your monthly mortgage principal, interest, and private mortgage insurance (PMI) payments into your costs. If the property has 20% equity, you aren’t required to pay PMI. Also, calculate the financing costs including the appraisal, loan origination fees, and closing costs.
How to Make Money on Vacation Rental Properties
Popular ways to make money on vacation rental properties include advertising on Airbnb, Vrbo, and other online vacation rental platforms. Some high tourist areas have local magazines for advertising vacation properties. If you hire a property management company, they advertise the property for you.
Airbnb
Airbnb is an online platform that lets you rent out your vacation property to tourists looking for hotel alternatives. You can create a property listing with a description of the property’s amenities, number of bedrooms and bathrooms, and any other highlights. Include photos with your listing that are taken during the day for the best lighting.
Airbnb charges a service fee every time a booking is completed on the site. The service fee ranges from 3% to 5%. Taxes are included if the region requires it, but the service fee is calculated from the booking subtotal before fees and taxes are added. Fees are deducted automatically from your payout.
Vrbo
Vacation Rental by Owner (Vrbo), is an online classified ad site. You can manage the property yourself or hire a property manager to list on Vrbo. Vrbo offers several fee structures, including a $399 annual subscription for long-term rentals and an 8% booking fee if you self-manage your listing or 13% booking fee if you want the listing managed for you by Vrbo. The fees are deducted automatically from the rental income.
3. Finance the Vacation Rental Property
Vacation rental properties usually are financed with a conforming loan, portfolio loan, multifamily loan or, in some cases, a short-term loan such as a hard money loan or a bridge loan.
Conforming Loan
Lending qualifications for a conforming loan on a vacation rental property are more lenient than for a standard rental property but stricter than for a primary residence. Lenders know that borrowers will be living there for part of the year and not entirely dependent on rental income to pay the mortgage. A 20% down payment and a credit score over 680 is typical. If you’re buying the property as a second home, to qualify for low interest rates, the lender may restrict your renting it to vacationers for a year.
Portfolio Loan
A portfolio loan can be used by an investor who wants to finance multiple properties at once. It also can be used to finance a multiunit vacation property. Portfolio loans usually offer lower personal qualifications and fewer property requirements.
Multifamily Loan
A multifamily loan is used to finance a multifamily vacation property with two- to- four-units or an apartment building with more than four units. There are four types of multifamily loans: conventional mortgages, government-backed loans, portfolio loans, and short-term multifamily financing. Each type of loan has its own lending criteria.
Short-term Loan
A bridge loan is a short-term loan that can be used as interim financing. For example, if you find a great deal on a property and want to buy it before you have long-term financing in place, a bridge loan could work. These loans generally have more lenient qualifications than conforming loans.
Another alternative is a hard money loan. This is ideal for a property that needs to be rehabbed or seasoned before you refinance it with a permanent loan. Hard money lenders base their loans on the after repair value (ARV) of the property rather than just the borrower’s financial standing.
4. Hire Operational Services
Once you buy your vacation rental property, you can either manage it yourself or get someone else to do it for you. If you’re going to manage the property yourself and you live a distance from the property, you’ll want to hire lawn care maintenance and cleaners. If you have a pool, you will need a pool company to clean and care for the pool.
If your vacation property has an HOA, they’ll take care of the exterior and common areas for you. If you hire a property manager, they typically handle operations for you.
5. Advertise & Manage the Vacation Property
You or your property manager can list the property’s availability on the websites we mentioned earlier to expose it to vacationers. When you list availability, block off the days you want to use it so no one else can rent it during that time.
If you live a distance from your property and manage it yourself, you’ll need a system to let service staff and guests into the property. Some owners have a keypad that renters use to get into the property and then reset it between each use. Alternatively, you can hire a management company to manage the property for you, saving you time since you don’t have to be involved in the daily operations.
Vacation Rental Property Tax Benefits
One of the benefits of purchasing a vacation rental property is that it offers tax benefits including being able to deduct a portion of your real estate taxes, HOA fees, and your mortgage interest expenses.
Real Estate Taxes
If you rent out your vacation property for more than 14 days per year, the property is treated like a rental property by the IRS. However, if you use the property for more than 10% of the days it’s rented, then it’s considered a personal residence. You can deduct real estate property taxes on your income taxes, but you should hire a CPA who is familiar with the differences between vacation rental property and a personal residence or when a second home is used for vacation rental income as well.
HOA Fees
HOA fees are only deductible if the vacation rental property is rented 14 days or more per year. Otherwise, the property is considered a second home, and the fees are not tax-deductible.
Mortgage Interest Expenses
Mortgage interest expenses have similar guidelines to real estate taxes when it comes to tax benefits and deductions. You can deduct 100% of mortgage interest under the second home rule if you rent the property for 14 days or less per year. This applies to properties up to $1.1 million. If you rent the property for more than 14 days, you can deduct mortgage interest from your rental income.
Pros and Cons of Buying a Vacation Rental Property
Buying a vacation rental property can provide a place for you to vacation while offsetting some of the property expenses with rental income when you’re not using it. Short-term rental rates are usually higher than long-term rental rates, but maintenance expenses, utilities, advertising, and management fees can quickly add up.
Pros of buying vacation rental property include:
A vacation property can provide another source of supplemental income
Rental income can offset property and vacation expenses
You can take advantage of tax deductions
The property can appreciate in value
You can enjoy your vacation rental property when you want
Cons of buying vacation rental property include:
You will have to cover property taxes, maintenance and utility bills, regardless of whether the property is rented
You may have to pay a property manager to take care of operations
Vacation rental properties are usually hit harder during economic downturns since people often eliminate or cut back on vacations to save money
Cash flow can be inconsistent since renters are usually seasonal, and off-peak seasons generate lower per night rent
Bottom Line
Buying a vacation rental property can be a great way to invest in real estate, offset some homeownership expenses, and still enjoy your favorite vacation spot from your own second home. These properties can yield high rents but can be seasonal, and they also have costly expenses associated with them.
About the Author
https://fitsmallbusiness.com/author/mpattersonfitsmallbusiness-com/
Find Melanie On
Melanie Patterson
Melanie Patterson, MA, CBA is a staff writer at Fit Small Business specializing in Real Estate Investing with over 25 years of combined experience in real estate sales, property management, and residential buy-and-hold real estate investing. In addition to managing her own property, Melanie has also managed a women’s emergency shelter.