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Today's topic is something I discuss weekly with our community: What type of rental properties should you invest in? What makes sense? What is better for your investment profile? What are the pros and cons?
For those new to the world of real estate investing, it's important to know that there are two main categories of rental investment types: short-term and long-term rentals. And if you're wondering about the differences between the two, you're not alone.
When I first started investing in real estate, I realized that I needed to get to grips with many key concepts. Ultimately, that would best position me to make investment decisions that would help me achieve my financial goals. This is absolutely true when it comes to investing in rental properties.
Today we'll go through both types of rental investments, including how they work as investments and the potential pros and cons of selecting them as part of your investment portfolio. We'll cover their expected returns, management fees, risk profiles, tax implications, and time commitments.
So sit back and get ready to continue your investment education—you'll be one step closer to achieving lasting wealth and living the life of your dreams. Along the way, be sure to stay active in your communities and work with your financial team to best align your decisions with your overall financial goals.
What are short-term and long-term rentals?
First, the basics. Short-term rentals are defined as investment properties where the renter stays for one to thirty days, such as vacation rentals or Airbnbs. For example, a beach condo that is rented out during the summer. Renters appreciate the flexibility that short-term rentals offer compared to hotels. These properties are easily accessible through technology like Airbnb, VRBO, and HomeAway, benefiting both vacationers and property owners.
Long-term rentals, on the other hand, extend over periods of one year or more and are aimed at tenants who are looking for a permanent apartment. An example would be renting an apartment for several years while studying.
There is a middle ground between these two types, called medium-term leases. I'll go into more detail about this in a future blog, but tenants range in length from one to twelve months. These offer a balance of flexibility and stability for both landlords and tenants.
Comparison between short term and long term
Let's look at some key considerations to keep in mind when comparing both asset classes for your own investment portfolio. However, keep in mind that this is not an exhaustive list and you need to do your due diligence when evaluating which might be best for you.
Returns and vacancy rates
These two concepts go hand in hand as one directly impacts the other. Short-term rentals are expected to bring in higher returns. This is because the price of shortened stays is more in line with that of a hotel stay. Short-term rentals are part of the hospitality industry, after all. It depends on the property, but short-term rentals have higher vacancy rates, which sometimes has a sobering impact on the temptingly high returns they offer.
Long-term rentals provide a stable, predictable income. This income is earned at comparatively low rates because their prices are determined by the housing market. In addition, vacancy rates are much lower with leases and the constant demand for housing.
Property management fees
Although it may surprise some, short-term rentals tend to incur higher management fees due to frequent turnover and guest services. It's not uncommon for the owner of a short-term rental to live out of state, requiring the hiring of a manager to oversee the property. Expect fees to be around 20-30% of your gross income.
Long-term rentals, on the other hand, generally have lower management fees because they require less supervision, aside from occasional repairs. The majority of the work is devoted to tenant retention. Fees for long-term rentals are usually between 5 and 10% of gross income.
Risk management
Laws governing short-term rentals can change more frequently, creating a greater risk profile than long-term rentals. An extreme but not unheard of example is a ban on short-term rentals in the area of the investment property. There is also seasonal demand. For example, if the property is near a ski resort, it may not generate much income in the summer. Are you willing to take the risk of fluctuations in demand?
With long-term leases, the biggest risk is tenant default. If tenants terminate their lease, the property's predictable income will be compromised until you find a new tenant. There are also risks in rent pricing. Market changes in demand can affect how much rent you can charge. Regulatory risks to consider include eviction moratoriums and rent caps.
Tax implications and management
And what about your taxes? Short-term rentals are business, so you can deduct expenses like cleaning and maintenance. This can significantly reduce your tax burden, since rental income is usually taxed the same as regular income. However, you do have options for planning your taxes to save as efficiently as possible. For example, you may qualify for a short-term rental tax loophole that allows you to offset active income against rental losses. However, you must be qualified as a real estate professional to take advantage of this.
Long-term rentals tax rental income differently. However, this tax burden can be reduced through depreciation and long-term capital gains tax rates. These benefits depend on how long you plan to keep the long-term rental as an investment. For both asset classes, be sure to work with your tax advisor to keep more money in your wallet.
Time required
If you're like me, you want to create passive income streams to build lasting wealth and live a dream life. For some, that dream life might include a side job, like working in property management. For others, though, you don't want to do the extra work. So let's look at the time commitment for both forms of rental investing.
In the short-term rental industry, there are more common administrative tasks, such as guest communication, cleaning rotations, regular maintenance, and marketing. Whether you want to spend your time on this is up to you, but if you are looking for more passive income, consider hiring a property manager to manage your short-term rentals.
Long-term rentals require less immediate attention and are less time-consuming overall. You can spend your time building professional relationships with your tenants. You will also occasionally need to repair parts of the property, either by taking the time to do the work yourself or by choosing the right contractor.
Which type of rental is right for you?
Careful consideration through education and understanding individual investment goals is critical to deciding what type of investment you want to consider. What are your goals, your risk tolerance, and your willingness to manage a property? These are factors, but so are many other things.
Want more? No matter where you are on your real estate investing learning journey, you can benefit from our Passive Real Estate Academy! It's a four-week course that will give you all the fundamental knowledge on how to make passive income from real estate investing. You'll also learn about current real estate market conditions and work with a group of like-minded investors to network and make connections.
Click here to sign up for our fall group by getting on the waitlist. We hope to see you in the fall! And regardless of when we see you next, we here at Passive Income MD hope you are taking the necessary actionable steps to make your financial goals a reality.
Peter Kim, MD, is the founder of Passive Income MD, the creator of the Passive Real Estate Academy, and provides weekly training through his Monday podcast, the Passive Income MD Podcast. Join our community in the Passive Income Doc Facebook group.
Create your very own Auto Publish News/Blog Site and Earn Passive Income in Just 4 Easy Steps
