Million dollars: Multifamily or short term vacation rental??

Question

We have multiple single family long term rental properties in our portfolio (being self managed) and are looking to add/diversify. We have about a million budget and are trying to decide between getting a tri or quadplex close to home for long term rentals and continue to self manage or invest in a short term vacation property up in the TN or NC mountains near a city with plenty of tourism (Gatlinburg, Asheville, etc.) what would you do and why??

Eric Fernwood · Answer

Hello Rosemary,

You asked a great question. Basically, given a sum of money, what is the best way to achieve your goals. I believe the first step is defining your goals. Once you define your goals, the rest should follow.

Goals

• Your starting point - How much capital and credit do you have or expect to have in a reasonable time frame? It sounds like you have already done this part and came up with an investable amount.
• The end goal - This is usually something like $10,000/Mo. income, in present value dollars.
• Time frame - The shorter your time frame to reach your goal, the more initial capital and credit you will need.

For the rest of this post, I will assume that you want to create a reliable passive income stream that you will not outlive. If this is the case, the location is critical.

Location

The most important investment decision you will make is the location, not the property. And, the most important location selection factor is the appreciation rate. Why? Inflation.

Dollars (the pieces of paper) have no value on their own. What makes dollars valuable is the goods and services you can buy with them. However, inflation is constantly eroding the buying power of the dollar. Each time you go to the grocery store, you have to spend more dollars to buy the same set of goods. Only if your rents increase faster than the inflation rate will you have the increased number of dollars to have the same buying power as you did in the past.  The chart below shows what happens to your buying power at various rent increase rates assuming a 6% inflation rate.

For example, if the rent starts at $1,500/Mo and increases 4% per year, you've lost 12% in buying power after five years due to inflation (currently 6%). If rents increased 2% per year, your buying power decreased by 57% after ten years.

Inflation is why you should only buy properties in a location where rents and prices are increasing at or above the inflation rate. Also, ignore the COVID frenzy period; this will not last. Evaluate the location based on the ten years before COVID (2009 to 2019).

You may have noticed that I use rent increase and appreciation interchangeably. The reason is that appreciation and rents are tied together. If prices increase (appreciation), rent will follow, but with a 2 to 10-year lag depending on the market. What is happening with property prices today is an excellent indicator of what will happen with rents in the future.

Property

Every property is most attractive to a fairly narrow tenant pool. So, when you select a property, you are also selecting a tenant pool, maintenance cost, and the vacancy rate. See the diagram below.

I recommend you turn the process around and start by selecting the tenant pool with the longest average length of stay. Next, select properties that match your tenant pool based on initial return and probable maintenance cost. By following the method illustrated below, you minimize vacancy cost and maintenance cost while maximizing rent.

Rosemary, if you stay focused on your financial goal and follow the steps below, I think you will do well.

I hope this helps.

William Beck · Answer

If the budget is a million you could definitely do both. Maybe open your mind to other markets for STR & LTR since the returns you'll get in a market close to home may not work out based on where you live.

Malgorzata Sadowska · Answer

MFR zoned for STR (that you can always LTR, if circumstances change).

Jeff McKee · Answer

I agree with the feedback thus far.  For us we are co-sponsors on 2,600 doors so we are focused on Lifestyle STRs where they will generate very good cash flow and where our family can spend a couple weeks out of the year there.   Looking at some of the same places (TN, Carolinas but also Florida and lakes in Texas).  In terms of property management we will build in the 20% - 30% 3rd party property management along with direct booking website with some AirBnb/VRBO to fill in the gaps in the bookings.  Again, that is just where we are with our investing and personal preference to own STRs in great vacation locations.  We will use the 10% down 2nd home loan option for each of these in different vacation spots.

Bud Gaffney · Answer

Multi, Multi, Multi!

Adam Lacey · Answer

I would say it comes down to your preference of time vs return. From what I hear, the cashflow on STR properties in the Smoky mountains is great right now, but managing an STR is time consuming. Owning a small MF most likely generate quite as high cashflow, but should be less time consuming. It's a tough choice. Of those two options, I would probably opt for the cabin in the mountains for the positive cashflow, plus you have a place to visit when not rented.

Brian G. · Answer

@Rosemary Saleeba I would buy an STR primarily because it meets our current goal which is to jack up our income and get maximum ROI. STRs are not nearly as passive as LTRs but they can really juice your returns if you learn to self manage remotely. Good luck with your decision.

Doug H. · Answer

@Rosemary Saleeba

I think it depends on where you are in relation to your goal.  If you have reached the ‘first turn’ where your RE income has surpassed your annual needs and a buffer for growth, then LTRs are much more scalable with less effort.

STRs are an actively managed business.  It can be fun.  It’s certainly a  ‘doable’ amount of work in addition to a normal 9-to-5, especially at a low number of STRs.  But, the right STR can be a significantly higher CoC. So, if you are still accelerating toward the ‘first turn’, then a STR might be the play.

Million dollars: Multifamily or short term vacation rental??

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