If you’re thinking about buying a vacation rental property, you’ll definitely want to conduct due diligence not only on the broader industry but also on the purchasing process itself.
Whether you’re on the fence or you’ve already decided that you want to buy a vacation home, there are three distinct phases you’ll go through when purchasing a vacation rental property. This post will equip you with the knowledge you need to make educated decisions about your investment.
Phase 1: Market Selection
The process of buying a vacation rental property starts with the market. In other words: location, location, location.
One of the biggest hurdles new STR owners and investors have to jump is that of narrowing down the market they want to enter. There are many variables to consider and it’s easy to get stuck in analysis paralysis. But if you following the process of elimination, you can start crossing off markets that don’t make sense and start zeroing in on the ones that show the most promise for short-term rental success.
If you’re reading this, you likely already have a few markets on your list. But if not, go ahead and jot down a list of 5 – 10 markets that seem interesting or feasible in terms of investment. A “market” can be defined as a geographical area of any size such as a country, a state, county, or even a specific neighborhood. Generally speaking, though, a market usually refers to a particular city.
Then, go through the steps below asking questions about the markets you have on your list so you can start to narrow down your selection…
Need help choosing a market?
Savvy will help you select a market that’s a perfect fit for you! And if you don’t already have an agent, we’ll connect you with the right people so you have everything you need to purchase your first (or next) vacation rental property.
When buying a vacation rental specifically for investment purposes, understanding the short-term rental regulations is paramount. If you the regulations state that vacation rentals aren’t allowed, then you can very easily determine that the market is not a great fit for your STR investment property.
You can usually find the rules and regulations on the city or county website in the planning department’s section. If the site doesn’t have a specific page for vacation rentals, try looking under zoning or permitting sections.
Here are some of the regulatory items you’ll want to learn about:
- Application process for registering a vacation rental
- Requirements and/or pre-requisites for eligibility to apply
- Costs for permitting and registrations (either personally or as an LLC)
- Limitations in permits (i.e. how many STRs are allowed)
- Violations and associated fines or penalties
- Geographical limitations (as in, are there only certain areas in the market that allow vacation rentals?)
Since vacation rentals have been getting a lot of attention over the last few years, some markets are changing existing regulations or working to create new ones from scratch out of necessity.
At some point you’ll probably encounter some regulatory language around STRs that you can’t understand because it’s so outdated or obscure. If you’re having making sense of things, don’t be afraid to call the planning department directly and ask for clarity. After all, it’s better to know before you go all in on this place!
*** WARNING ***
If you’re planning to buy a vacation rental purely for investment purposes, we advise not entering any market where regulations aren’t already established. It’s much safer to purchase a vacation rental property in a market where STR regulations already exist because that means the city has made it over the “hump” of adoption.
Next up is profitability. This is probably the most obvious but not always the easiest to figure out. Especially when you’re newer to the space, it might be hard to tell what’s what in terms of ROI.
Important to note here is that “profitability” consists of three main components:
- Cost of Acquisition
- Operating Income
- Operating Expenses
Figuring out these three numbers will put you in the right ball park of figuring out how profitable a vacation rental can really be.
However, these numbers apply more to a specific property than a specific market. So how do you use these numbers to inform your market selection?
One word: Revenue.
Revenue can be your flashlight in a dark cave of the unknown. When you’re looking at different markets, find out the overall revenue numbers for each market.
That’s not to say you want to pick the market with the most revenue, as this could be a sign of over-saturation. In general, though, a market with more overall revenue is usually a good indicator that vacation rentals work well there.
Some specific revenue numbers to look at include average total annual revenue per property and the average daily rate.
The average annual revenue will give you an idea of what you might hope to earn with an average property in that market (you can also compare the median annual revenue to gauge variances between different property types).
The average daily rate (aka ADR) will tell you not only how much people are willing to pay for a night in your vacation rental but also what kind of people are booking these places. Trust us, the people booking an Airbnb at $100 a night are a lot different than those booking at $800 a night.
Some other ways to gauge the revenue potential of the market is to look at visitation and tourism trends which are often publicly available. Seeing a steady growth in visitor demand over years could be an indication that the future demand of vacation rentals is strong.
Lastly, if you’re buying a vacation rental property and you’re trying to pick which market to buy in, you need to be clear on the reason for buying it.
Purchasing a vacation rental property strictly as an investment makes market selection a little easier because it’s all about the numbers. How much is it to buy in? How much can I expect to earn? What are the risks, and the upsides?
These are great questions to ask when buying a short-term rental investment property. However, if you’re looking to buy a property to be used primarily as a vacation home (and the income is secondary), a different set of questions will be driving your decision about market…
What kind of home do you want to enjoy? Should it be a cabin, a villa, a beach house, or perhaps a unique stay like a dome, a yurt, or glamping tent?
How often do you want to use it? Should it be within driving distance of your primary home or are you okay with a 4-hour flight across the country?
Do you want to be involved in the process of setting it up and running it? Or would you rather be hands-off with the project and have someone else do the work?
How much do you want to spend? Do you have a lot of discretionary cash waiting to be put to good use, or is the process of purchasing a vacation home going to put you through the wringer?
Some of these questions are preferential, others personal, but all of them will sway your market decision one way or another. For example, if you’re set on buying a cabin, you’ll quickly see that only certain markets make sense for this kind of vacation home.
If you’re tight on cash, for instance, you’re not going to want to buy a vacation rental property in a place like San Francisco because it’s one of the higher-cost markets in the U.S.
Take some time to think about your intention and get clear on what you want. By answering these questions, you’ll gain insight and start narrowing down the options until you arrive at one or two markets.
Phase 2: Financing Plan
Before buying a vacation rental property, you’ll need to come up with a game plan for purchasing it. If you have the cash to buy it outright, go ahead and skip this section. Otherwise, read on to learn how to strategize a financing plan that works for you.
Purchasing power translates to one basic question: What can you afford?
When initially purchasing a vacation rental property, you’ll need to know your budget and the best way to do that is to know the costs of acquisition. As with any real estate purchase, you have your down payment and closing costs.
What’s different about vacation rentals, however, is that you also need to budget for startup costs.
Startup costs include things like design and furnishings, basic supplies to get started, home improvement projects, and preventative maintenance to stop potential issues before they turn into something bigger.
When budgeting for design and furnishings, there are two ways to estimate this number.
The first is to gauge it by rooms or areas in the house. So for example, a 3/2 single-family residence would have 3 bedrooms, 2 bathrooms, a living room, kitchen, and probably a garage and/or backyard or patio. So in total, that’s about 8 or 9 “areas” that make up the house.
Now multiply the number of areas by an average cost to get the estimated budget. On the lower end, it might be $2,000 – $3,000 while the higher end might be somewhere between $5,000 – $7,000 per area.
In total, then, the furnishings budget could be as little as $15,000 or as high as $60,000. Again, what’s your intention in buying a vacation rental property? The answer should help guide your budgeting decision.
The right upgrades can drastically increase your rental revenue
The cost of supplies usually depend on the size of the property but they end up being pretty nominal in any case.
Home improvements can be scaled up or down depending on how much cash you want to put in. For example, a pool or hot tub would make sense in a desert market because it’s one of the most sought-after amenities. Not only will it increase the earning potential of your vacation rental property but it will also increase the appraisal value. The earlier you put this in, the better, so why not bake it into the initial budget?
Other improvements can be held off for the right time. For example, if you want to install a custom fire pit, there’s no need to do it in the dead of summer. You can wait until fall or winter to do that.
Indeed, STRs tend to have a higher cost to get started but if you do it right, these costs pay for themselves multiple times over in the long run.
In fact, Savvy has actually opted to front the startup costs for some of the properties we manage because we’ve seen what a difference it makes. It’s better to spend up front if you can because it pays off later in the ADR and total revenue the property ends up generating (not to mention avoiding refunds caused by issues that could have been prevented).
Now what if you don’t have the cash in hand to buy a vacation rental property but you earn enough to secure financing?
There are way too many financing options for real estate to cover them all in this post, but here are a few of the main ones to consider:
SECOND HOME LOAN
If you already have a primary residence, you can apply for a second home loan. This kind fo loan requires that you live at least 50 miles away from the vacation rental property.
The interest rate and down payment are usually a bit lower too, at 2-3% and as low as 8-10% respectively. The caveat with this type of loan, though, is that the property cannot be held by an LLC which is a common practice for those buying short-term rental investment properties.
Another stipulation to be aware of is that you have to use the property at least 14 days out of the year (depending on the market) and you can only own one in any particular market (meaning you can’t buy 2 or more STRs in the same city with this loan).
STR Investment Loans
Some lenders offer a loan product specifically built for short-term rental investment properties. With these loans, the lender underwrites the property instead of you, the individual because they are asset-based loans instead of personal loans.
With these loans, the property can be held by an LLC but the tradeoff is a higher down payment and interest rate. When you crunch the numbers, this might still make sense because STRs generate higher revenue than traditional long-term rental properties.
If you have a good relationship with a bank or lender that doesn’t provide an STR-specific loan, you can also ask them about a traditional investment loan and let them know what you’re trying to do. They might be able to work with you on the terms and offer a sweeter deal if you can demonstrate strong potential.
Finding a parter to help with the financing is also an option. If you partner with someone when buying an STR property, the risk is divided and you also increase your purchasing power.
Partnerships are tricky, though, and you’ll need to consider a few variables before inking anything with someone you know (or don’t know). This includes how you’re splitting costs and fees, equity and appreciation, as well as who makes decisions.
Partner with Savvy VRM
Did you know Savvy works with owners regardless of what phase they’re in? If you’re buying a vacation rental and you want to increase your chance of hitting a home run, give us a call and let’s discuss how we can help one another.
Phase 3: Property Acquisition
As you go through the process of buying a vacation rental property, the final stage is actually picking the property and purchasing it.
At this point, you’ve selected your market and have come up with a financing plan so you know what kind of property you can afford to buy. Now it’s time to start the search and practice analyzing properties to see if it’s a good fit for you.
Basically, this boils down to understanding the type of people that are renting in your chosen market, and being aware of the resources at your disposal to find the right kind of property.
What to Look for in a Vacation Rental
Try to understand what types of people are going to be visiting the market, and what they’ll be doing.
Is this a party market like Nashville, where people go to celebrate a bachelor or bachelorette party? If so, you may want to look for bigger properties that can hold a lot of beds or something with multiple levels like a town home with a rooftop deck.
Or is it quieter market where couples go to relax for the weekend, like a beach on the Florida coast? If that’s the case, scope out quaint neighborhoods and find a charming home or bungalow that would appeal to the love birds.
By understanding the people who will be renting, you can look for properties that are best fit to serve the needs of the travelers.
In the same respect, you can filter properties by amenities. For example, if you’re purchasing a vacation rental property in a desert market, you’ll want to filter your search by those properties that have pools (unless you’re planning to install your own).
If you’re buying a short-term rental investment property in a ski market, maybe you filter your search by those that have a mud room, or sauna or hot tub. Or maybe you want to get something that offers a ski-in / ski-out location.
On the other hand, if you’re buying in a lake market, try to nab a property that’s on the water and has its own private dock.
Amenities make a big difference and help you stand out from the competition when you start listing your vacation rental. The more amenities that come with the property, the better.
Where to Find the Perfect Investment Property
Now that you know what you’re looking for, where do you find it?
The obvious answer is a real estate agent. If you already have a relationship with someone, that’s great! Tell them what you’re looking for and they’ll do all the work.
If you don’t know anyone in the market you’re looking to buy in, give us a call and we’ll introduce you to someone we know.
Maybe you’re a DIYer and want to be more hands-on in the process…
In that case, you can search for market deals on the MLS using real estate aggregators like Zillow or Redfin. There are also new companies starting to zero in on STR buyers specifically so they only aggregate those homes that are fit to be used as a vacation rental. One example is Revedy and another is Vrolio.
You can also get access to off-market deals by networking in the local area you’re wanting to buy in. By joining a real estate investment group, you’ll meet wholesales, agents, lenders, and many others who are usually all in the know about inventory before it goes live to the public.
Want Help from Industry Experts?
Buying a vacation rental property is quite the process, but you don’t have to do it alone. At Savvy, we want to see you succeed whether you plan on hiring a management company or not.
If you want help purchasing a short-term rental investment property, don’t hesitate to reach out for some professional guidance before you buy. We’ll help you create a game plan and offer our best tips for making sure your vacation rental investment is a smashing success!