We often get questions about investing in vacation properties on our communities. Many members of our communities own short-term rental properties. It can be a very lucrative alternative income stream, with many members making over 6 figures annually from their short-term rentals with minimal work, especially if using a property management company. As an added benefit, depending on how you choose to approach it, you have a vacation property you could use for yourself, family, and friends.
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Quick Links
Resources
AirDNA: AirDNA provides market and property data and insights for the short-term rental market, assisting property owners and investors in making informed decisions about vacation rentals.
Short-Term Rental Courses:
Accelerating Wealth: Short-Term Rental Blueprint - run by a married hospitalist couple that walks you through how to find the right short term rental investment, the business of owning a short term rental, and tax savings.
There are also more courses that also cover short term rentals in addition to other forms of real estate investing on our real estate investing for physicians page under Active Real Estate Investing courses.
Free Real Estate Educational Events on Short Term Rentals (you must be a member of our communities to access these)
A Word of Caution
Let’s start with the warnings, as investing in short-term rentals has become glorified in many physician circles over the past few years. This is because of how lucrative short term rentals have been in recent years, as spurred by the increased popularity of vacation rentals, such as AirBNB and VRBO, throughout the pandemic. Utilization soared, and along with it, rental prices. All the while, interest rates plummeted, making mortgages cheaper and net cash flow much more appealing. Additionally, new tax laws opened up the possibility of the so called ‘Short-Term Rental tax loophole,’ which allowed owners to take maximum (as much as 100% at one point) depreciation on the property in paper losses - while the property itself was actually appreciating - against W-2 income. Combined with appreciating property values in high demand areas, they became very attractive investments, particularly for physicians and other high-income earners who don’t get a lot of tax breaks.
Well, some of this has changed. Mortgage rates have gone up significantly and inflation has increased, increasing expenses and decreasing profits. On top of these factors, many people have returned to using hotels as their preferred vacation accommodation. As a result, occupancy rates are down in many markets. Then there are the risks that have always existed in short-term rentals:
The possibility of changing laws that preclude you being able to rent your property
Natural disasters in some popular markets within short-term rentals
The damages short term renters may do to your property when in vacation mode
The impact on the asset class during recessionary periods
Day-to-day issues that come up with renting to tenants that are constantly turning over
The risk of owning single properties where things can go wrong and throw the entire property out of cashflow mode until issues (that could be expensive) are fixed.
The Right Short-Term Rental
Does this mean you should never invest in a short-term rental? No - there are still benefits to be had, just as there were before the pandemic and when interest rates were higher - with the right properties. It reinforces what we’ve always said, which is that you should plan for the worst when you take on an investment property, and make sure that the numbers still make sense in that scenario. What we don’t want you to do is buy out of FOMO, or assume that something will work itself out. These are investment properties and should be treated as such, without an emotional component. Making educated purchases is key.
Conservative underwriting will save you in most cases. When you are plugging numbers into a cash-on-cash calculator, you want to assume high interest rates, high costs for property management companies, low occupancy, and in today’s market, not factor in potential appreciation. You should only buy a property if it cash flows despite your most conservative estimates (which can be based on local expertise like a local investor agent or realtor or data on something like AirDNA).
Benefits of Short-Term Rentals
As with any investment, know why you’re picking a certain asset class and how it fits into your overall portfolio. Reasons to consider short term rentals include:
the ability for higher cashflow
the tax benefits
income and asset diversification
the potential for appreciation of the property
the ability to use the property for your family’s own vacations (but you should do this minimally if you’re planning on using the short term rental tax loophole!)
Even when accounting for using a property management company, short term rentals (assuming they are occupied) will usually generate much higher cashflow potential per night than a long-term rental. This cashflow can potentially pay off a property that you wanted to have anyways for personal use, which a lot of physicians find attractive as well.
A unique feature of short-term rentals as an asset class is the ability to both invest in real estate as well as run a business. For those that are more creative or entrepreneurial, short-term rentals offer much higher profit potential because of the ability to carve out a niche or make your property unique enough to command prices far above market rates. Think of the more unique vacation rentals you’ve seen - treehouses, themed rooms, houses tailored towards reunions or corporate gatherings. When these properties gain visibility and a positive reputation, you may be able to rent them out for rates that far exceed the cost of ownership, making them quite lucrative.
The Short Term Rental Tax Loophole
Lastly, but not the least importantly, people really like the very popular "short term rental tax loophole." It is definitely an intriguing concept - as most physicians are W2 earners, they don't get a lot of tax deductions or opportunities for tax advantages (these are basically the extent of what you get). However, real estate offers some great opportunities for tax savings. In the long term rental market there is the famed 'Real Estate Professional Status' - however this only works if you or your significant other as applicable are able to accurately say that you do real estate as your primary job and more than anything else, as explained here.
The cool thing about the short term rental tax loophole is that if you meet the criteria for material participation you can, even if you are a full time working physician, still use depreciation against your active W2 income as a physician to reduce how much of your physician income is subject to income tax. Provided that you buy and put into service the rental property for short stays (per IRS, this is defined as an average of <7 days), as well as meet other criteria for material participation as defined here on the IRS website, you can actually count the depreciation of the property against your W2 income to reduce your taxable income. Typically the depreciation is done over a defined period of time. However, currently (phasing out gradually by 2027), you can even do something called bonus depreciation, where instead of spreading that depreciation over the larger period of time, you can take a large percentage of it in the first year and deduct that amount against your W2 income. Some doctors are able to actually declare zero dollars in taxable income in the year that they buy these properties because of this. Again, the details of this require working with an accountant savvy in real estate who can ensure that you are in compliance with the guidelines set by the IRS.
You can read more about these special areas of the tax code on the IRS website here.
Short-Term vs. "Mid-Term" Rentals
While the IRS defines short-term rentals as less than or equal to 7 days when considering the short-term rental tax loophole, many people who invest in short-term rentals actually use these properties as ‘mid-term rentals’ as well. This could be tailored towards people whose insurance companies are paying for them to stay elsewhere while their house is being repaired, corporate relocations, and traveling healthcare professionals such as locums physicians or traveling nurses. It may be that your property is used for different things at different stages of the economic cycle. That’s fine! When you’re vetting properties, think about the different ways you could use the property if conditions or laws shift. As with most side gigs, the ability to pivot will make your endeavors more profitable.
Successful Short-Term Rentals
Keep your eyes out for properties that will generate cash flow and buy smart. Look for deals, find ways in which your property has a unique value proposition that will make people want it more than other options, and look for ways where you can improve the property to force appreciation. Avoid oversaturated markets - it’s almost always better to be a big fish in a small pond than a small fish in a big pond.
Conclusion
There are no shortcuts to successful long term strategies. Discipline is essential. Don’t be in a hurry to buy - there will always be other opportunities. You should never jump into any investment until you know that it makes sense. The most important thing is to learn, learn, learn about real estate investing, so that you are educated enough to spot the right opportunities and ready to buy when they present themselves. Whenever economic conditions change, there are opportunities to be had for those that are prepared and have the cash to buy.