Hidden costs & considerations for out of state or STR vacation rental investors

[AJ Wong]

By my calculations we've assisted nearly two dozen out of state or area investors acquire, furnish and launch vacation rentals on the Oregon Coast the past two years. 

The typical investor profile is GenX or millennial individual or couple or a 1031X investor, seeking to maximize their working capital and cash flow. Usually they are considering several areas for vacation rental investment, and are often from within the state or nearby California, Washington or Oregon. 

They are attracted by nature, affordability and bang for the buck. Who doesn't want to own a profitable or paid for beach house? 

I've posted extensively about coastal Oregon vacation rentals and their challenges and production potential, typically a strong STR will generate roughly 10% of valuation in gross annual income.

My time is invested identifying the areas and properties that are both eligible for a vacation rental permit license and likely to produce investable rental revenue, but beyond negotiating and supporting the transaction, is the facilitation, transition and optimization to an active vacation rental.

Here are some key points for out of state investors of nightly vacation rentals to consider that are just as essential to success as the 'right' property:

- The RIGHT People 

Operating an AirBnB or mini hotel is hard work and it takes a tribe. Often for STR's to be profitable there will need to be high occupancy of over 200 nights per year. Guests, just like those at your personal residence, require all sorts of amenities we don't often think of beyond the heating, cooling, water, waste, electricity and internet that hosts are responsible for. Things such as; toilet paper, drinking water, pet supplies, linens and hot tub chemicals and cleanings that we didn't initially factor into our Pro Forma's..The costs of these are real, but even realer are the stocking, cleaning and preparing a space for visitors in a few hours between check ins. A proper manager, neighbor and handyman team are absolutely essential to effective management for out of state investors.

- Management Solutions 

Having began my STR focused career with Vacasa RE team I can tell you that vacation rental property management is expensive and you do not always get what you pay for :) For those that don't know Vacasa is essentially the Uber of property management for STR's. They were founded in Oregon (primarily on the Coast) and have grown rapidly into a unicorn public company as the largest vacation rental PM in the world* for vacation rental owners. Opinoins aside..they ultimately cost A LOT and as of recently hadn't quite delivered as expected for any property owners. WHY? They scaled very quickly and short term property management is HARD. Especially is difficult to reach places. How many quality cleaners are there in a 500-1000 person town? And how many vacation rentals that in summer need to all be turned over on the same days?

The solution is often to build your own team. AirBnB now has a tool to connect you with a local super host. A local candidate with a seller reputation that knows the area and can be your boots on the ground. Owners work out the compensation with the individual directly (typically around 10% of the revenue) and this generally reduces management costs from the standard (25-35%!) making many vacation rentals highly lucrative and with strong C.O.C. return projections of 10-25%. 

- Furniture & Decor 

Roughly half of the STR's clients have acquired the past two years have been sold furnished. There is some debate as to the difference that quality and relevant furnishing make to the bottom line. I personally think curating a space is important, some of our top producers have been very small and 'basic' spaces, but we presented them with IG worthy decor and finishings. That said, when you live several states away furnishing and launching a HOME for rent is ore involved than closing on a long term rental. Consider all of the effort that goes into moving your primary residence, essentially that needs to be replicated for a property out of state. Vacation rental dwellings require furniture and furnishings but also completely functional homes. Internet needs to be installed, dishes and cups put away and rugs, hand towels, mirrors and landscaping needs to be complete. This year we created an entire support rolodex for on the ground support for buyers post closing that includes; handymen, cleaners, contractors, licensing & permit consultants, interior designers, landscapers and hot tub cleaners. Essentially home owners and operators will require everything they need when their families moved to a new neighborhood. Neighbors and a community that guests can rely on as well.

My interior decorator, whom doubles as my fiancé, has a few tricks she uses to streamline property launches. She utilizes online Amazon & Costco A LOT. Usually ordering memory foam mattresses (that come in deliverable boxes) and bed frames. She'll thrift or go to estate or consignment stores for the heavy stuff; couches, dining tables and chairs and use a checklist to place one or two orders of ALL soft supplies (linens, towels, rugs) online or major Marshall's runs.  A typical budget for higher quality furnishings (recommended for wear & tear) is $25-3500 per bedroom. More so than where items are purchased, is how they are logistically coordinated. A small town has small stores. If a host desires big appeal and profits, it can take a little more effort than the local resources provide. 

- Mortgage terms, rates and competition

Typically vacation rental properties are investment properties. As many investors know, lenders typically require more down payment 15-25% and to utilize Debt Service Coverage Ratio or DSCR loans would not allow vacation rental projections or income to be utilized for qualifying purposes. This can result in higher mortgage rates and costs in comparison to 'market' mortgage rates and terms. Underwriting is slowly evolving as there are active lenders that will currently permit historical STR income or even an AirDNA projection as qualifying income. Additionally, many lenders have limited legal usage conditions for properties to qualify as second homes (particularly in coastal areas.) This can reduce the required down payment, often increase the allowable seller concession from 2 or 3% to 6% and lower the rate of interest, as well as expanding the types of mortgages eligible (in the case of ARM's, 40 year amortization, interest only or even 40 year interest only!?)

In the current market environment I've been a huge advocate of seller concessions to soften the costs of financing, improve cash flow or limit down payments for other capital improvements (such as upgrades or furniture) but often (especially turn-key vacation rentals) come with strong buyer competition. This can be transactionally prohibitive for more 'aggressive' offers with low down payments and high concessions, making buyers offers less attractive. Above all else timing is critical. On the coast a premium, existing STR, or vacation rental ready oceanview property will typically receive offers within 48-72 hours of listing. My best mortgage advice is to be locked and loaded! Get a strong pre-qual letter with an investor oriented and experienced lender (some of the best I've met on BP) and have a contingency plan. Know your options if you need to restructure as an unfurnished purchase, or if it's furnished and you need a seller concession to make it work. The unsung heroes of any real estate transaction are the mortgage broker or lender. They get the most responsibility with the least acknowledgment. I like to think that money comes first :)

- Upgrades and Renovations 

One area of opportunity with out STR's (at least on the coast) is condition. A quick search of comparable rentals will show that most are just properties that were turned over to others for rental. There are not a high proportion of curated or themed spaces on the coast. Many homes, their design and furnishings are near original or quite dated. Like the investors, many of the visitors can afford nice amenities but don't often have that option when it comes to AirBnB's. The most appealing and upgrading rentals are typically the most popular and lucrative. Amenities such as hot tubs and pet allowances can increase production by as much as 15-20%!? Likewise for outdoor showers, surf racks, saunas and a clean, non 70's tub with a walk in shower. It doesn't need to be luxurious but something from this millennia provides noticeable returns. With that said, installing a new bathroom or kitchen sink is increasingly expensive and on the coast (or any rural-ish location) contractors are notoriously unreliable..let's be honest, remodeling is always trouble. But for STR's it is almost always worth it. Now that is not to say that investors needs to purchase a property and gut it to make it profitable. What they can do is factor in upgrades over time. Possibly the property pays for it through production or re-leveraging through appreciation with a HELOC or 36 months zero interest payments from Home Depot? However and whenever it is factored, upgrades are critical to popular hospitality.

My friend does union hotel jobs in Las Vegas and the hotels there often have their new remodel contracts signed before the current job is complete! Major hotels will upgrade their rooms, bars, restaurants and casinos frequently, sometimes every 3-4 years. A reliable contractor or DIY husband/wife will be an integral part of hosting a desirable and profitable BNB.

- Refresh & Reinvest 

Expounding a little on the topic above, vacation rental ownership is not a set it and forget it. It's possible the property is supporting 200+ nights of occupancy comprised of 50-60-100 couples and families and possibly their pets. Hotel rooms take a beating, same goes for single family homes being utilized at a high capacity. Unlike hotel rooms, many of these properties were and are not designed for commercial usages. Theoretically three occupants is three occupants, but home owners and investors know the true cost of home ownership or real estate investment. Without constant and consistent care and 'Pride of Ownership' things break down or worse, fall apart. The tenants have no true relationship to the owner and similarly to a hotel, usually things get broken or go missing. It's just the nature of the beast. 

Your guests are not going to notice or care about the leak under the sink or that the hedges need to be trimmed. That is the hosts responsibility and if they live twelve hours away, they better have someone on the ground that cares and can treat it like their own. So similar to your own space, a seasonal, annual or semi annual refresh of the space and photos is critical. Guests want to arrive to the space they were sold. They want the linens to match and the place to smell and feel clean. Ikea furniture is functional and we use it all the time, however we all know when it's passed it's useful life. Same goes for appliances or other critical infrastructure. The best hosts can and do re-invest into their spaces. They treat it like their home that they share with others. To differentiate many owners theme or target certain demographics such as golfers, bachelorette parties or wedding groups. It's ok to experiment. The market is constantly evolving. AirBnB was founded in 2008 while the service as we know it, is just over a decade old. 

How many active short term vacation rentals do you think hosts have owned before AirBnB was created? 

Any hidden costs you would add to this list?