Economic and Legal Considerations for Short-Term Rental Businesses

Platforms such as Airbnb and VRBO have disrupted an industry once dominated by hotels and resorts, allowing individuals to open their homes and residential properties to travelers. The boom in short-term rentals has created new opportunities for investors who want to buy income-generating property. Nightly, weekly, and monthly rentals appeal to business and leisure travelers. Depending upon a property’s characteristics and location, it could generate tens of thousands of dollars per year in income and appreciate in value.

Like other investments, however, there are risks associated with a short-term rental property, and profits are not guaranteed. Investors can have some degree of control over the profitability of their short-term rental property by making informed decisions about location, pricing strategy, and the experience they want to provide their guests. Before entering the short-term rental market, investors should carefully consider location, target market, and other factors that can impact long-term success.

Short-Term Rental Economics

In some of the stronger short-term rental areas, the break-even time (i.e., the number of rental days per month needed to cover the owner’s monthly mortgage) is around 6 to 22 days.^[1] However, even in the hottest rental areas, economic headwinds and legal restrictions have led to uncertainty and challenges. The short-term rental market has cooled a bit after a post-COVID travel boom, which saw all-time highs in supply, demand, and total revenue. But the overall outlook for short-term rentals remains strong, with 5.5 percent growth in demand expected in 2023 and occupancy rates that remain above pre-pandemic levels.^[2]

Consider the following factors before investing in a short-term rental property.

Costs

Investors who purchase a property with the goal of entering the short-term rental market currently face the highest mortgage rates in years. Higher loan costs come on top of the usual costs associated with purchasing and owning a home, such as down payment, insurance, taxes, and utilities. Short-term rentals also involve other costs, such as purchasing a separate insurance policy and paying for frequent cleaning, repairs, and the latest amenities to maximize the guest experience.

Some short-term rental expenses are tax deductible.^[3] However, in addition to state and federal income taxes, owners may be subject to state sales, business, and franchise taxes and local short-term rental occupancy tax.

Location

As with all real estate, for a short-term rental, location is everything. Rentals in desirable locations can fetch higher daily rates and occupancy rates; however, those properties may also be more expensive to own. Rather than buying a rental property in the heart of a busy tourist destination, some investors choose to buy in an adjacent area with lower costs that is still attractive to travelers.

Note that some areas have banned short-term rentals outright or placed restrictions on them. New York City recently passed strict regulations on home-sharing that is likely to delist about 10,000 Airbnb units.^[4] St. George, Utah, is one of the best places to own a vacation rental, but city ordinances ban short-term stays in single-family neighborhoods, and anyone renting their home needs a business license.^[5] Dallas has also banned short-term rentals in single-family residential zones.

Competition

Owners can adjust rates based on location and popular travel times to increase cash flow. But in a more saturated short-term rental market, rates need to be competitive with both other rental units and local hotels.

Surging demand for short-term rentals has brought about record supply. More than half of short-term listings on Airbnb have entered the market since the start of 2020.^[6]

Consumer Tastes

Traveler fads can be as fickle as market conditions. Some travelers have become more environmentally conscious and are seeking out sustainable accommodations. For owners, this could mean prioritizing energy-efficient appliances, recycling, and other eco-friendly features.

But placing too much emphasis on the flavor of the day could result in upgrades that go out of style as quickly as they came in. For instance, prior to COVID, only 10 percent of short-term rentals were located in rural areas. That number doubled during the pandemic as travelers engaged in social distancing.^[7] Instead of prioritizing the latest trend, consider emphasizing timeless traveler appeals, such as comfort and convenience.

Turnover

When demand is high, owners can use surge pricing (what Airbnb calls “dynamic pricing”) to charge more per night. Nightly or weekend getaways may earn more per night than longer stays, but with higher turnover, there are also higher costs associated with more frequent cleanings and guest preparations.

Owners might consider discounts for longer stays, resulting in a lower daily rate but less frequent turnover and associated costs. Longer term rentals also make sense for areas that rely on seasonal tourists and have a low season that is appealing to budget-minded travelers and telecommuters.

The Bottom Line on Short-Term Rentals: Do Your Research

Investing in short-term rentals requires planning, preparation, and projections.

• First and foremost, local regulations for short-term rentals must be considered. Ensure that short-term rentals are permitted by the local government, and find out if you would need to obtain a business license and/or register a business entity. Also keep in mind that rules could change. Research whether there are proposed ordinances in the locale of interest that could affect short-term rentals.
• Understand pricing and set reasonable expectations. At a minimum, the projected income should be enough to cover the costs associated with the property. Be prepared for the expenses that will be incurred and learn which ones may be written off. Budget extra funds to cover unexpected costs. Keeping detailed records of costs and expenses will help investors generate better financial forecasts. Short-term rental market data can be tracked on analytics sites such as AirDNA.^[8]
• Determine a management strategy for the property. Owners can manage the property themselves or use a property management company. Although self-management is the cheaper option, it involves additional responsibilities such as cleaning, restocking, bookings, check-in and check-out, and guest communications. Mishandling these responsibilities can lead to a poor guest experience and bad reviews, which can make a property less competitive.
• List the property on popular booking platforms. Keep in mind that each platform has a different fee structure. It is necessary to invest the time required to set up a host profile, upload photos, and write property descriptions. Most owners list their property on multiple channels. Partnerships with local real estate agencies and local businesses can supplement booking site listings. Owners with multiple properties can set up their own rental site to cut out the middleman.

Whether you are a first-time or seasoned short-term rental owner, there are important legal issues you should consider, including compliance with state and local laws, obtaining licenses and permits, and creating a legal business entity to hold the property. If you have legal questions related to your short-term rental property, contact our office to schedule an appointment.