Have the EXTRAORDINARY Profits in STR Ended?

Question

I recently needed a STR in Phoenix for a 6 week stay. I was (pleasantly) surprised by the number, quality and pricing of offerings (February 1 - March 15). In my previous Phoenix trips the supply was much "tighter"; I ended up paying about $1,000 per month less this time, for a better neighborhood, nicer condo, and the host was willing to negotiate (a little) despite it being high season.

I was in the STR business (as investment only, my daughter ran the operation) 2014 - 2016 in NYC until we were effectively shut down as a test case of their municipal short term lodging ordinances by the City of NY. The attraction back then was that the ROI was well above what one could expect from the combination of INVESTMENT return and BUSINESS return; in other words the ROI exceeded a return for both capital and time.

So, my question is; in GENERAL, has the STR industry matured to the point where any excess return is really just a return for being in a business rather than just a real estate investment? Is the business now just like any other business, where there’s a return for capital and labor, but no “windfall”.  It seems that a lot of wanna bees believe that outsized profits still exist in the industry; but with prices of prime properties up 40% in 5 years, is that even possible?

Marcus Auerbach · Answer

The party with exuberant returns is clearly over, we are back to reality and normalized returns.

You can still make solid profits with STR, but the times where you could buy any weird cheap property, put some lipstick on and rake in the profits are over. Quality matters now and with that you see a consolidation to professional operators and prime locations. We have a few clients in Milwaukee who have traded out of STR and into LTR with us.

And even in vacation destinations, a wave of regulations down to the municipal level cuts into the viability of STR or in some cases renders them impossible.

Last summer we rented a house on a small lake in Wisconsin for a family gathering. It was great, someone brought a guitar and we I think 10 people are sitting around the firepit having a good time. Even though we are all in our 50s and kept it down, it was clear that we were the loudest on the little lake.

Most other homes were either dark or there were two people quietly enjoying a drink, like our neighbors. The homes are close together, each lot has maybe 80-100' of frontage. While they were good sports and did not say much other than hello, I could tell they would rather not have us there. And another group next weekend, maybe even less restrained. While most other homes are only occasionally used by their owners.

I can see how someone will go to the next townhall meeting and be angry about the nuisance STR brought to their quiet sanctuary ...

Tyler Divin · Answer

I would also add that the returns in any investment reflect the level of risk.  Yes, the competition has increased but also the risk of STRs has come down over the years due to a number of factors.  We have more data and more accurate data.  There is a lot more information and case studies of people being successful with STRs.  Sophisticated software tools have emerged including PMS, AI guest responses, dynamic pricing tools, etc.  The industry has matured and continues to mature so it's not the wild wild west anymore hence the wild wild west returns have gotten fewer and farther between.

Allan C. · Answer

Markets are efficient and all commodities reach equilibrium, especially with technology increasing market transparency. The party was over when everyone on BP started posting about killer profits a few years ago - it just took time for it to catch up.

everone should understand the fundamentals of investing - returns are a function of risk, effort and barriers to entry. Some folks may luck out with high returns for a short period of time, but that is not sustainable without taking on risk, high effort or having some barrier to entry.

Andrew Steffens · Answer

I think the word you used EXTRAORDINARY meaning EXTRA ORDINARY is key, as yes extraordinary is over and we are now firmly in ORDINARY territory.  There are exceptional properties and exceptional markets but I think the market has matured and things are more of a normalized returns part of the cycle.

Jules Aton · Answer

I think like anything when the masses jump on the bandwagon there will need to be a correction. Costs are higher to purchase, renovate and maintain now also. My thoughts are in high need areas like vacation spots there will always be money to be made but as RE goes expect it to wax and wane.

John Underwood · Answer

I do agree there is a correction. I think demand is still there for good locations and good properties, but saturation in certain areas is definitely hurting many that could get great income with minimal effort in the past.

You have to put in the work to set yourself apart from your competition.

The bar to entry is much higher now than years past.

I can buy a house from a motivated seller and get it going as a LTR and easily Net 12k per year so if your STR can't do better, why do the extra work that a STR requires? If your goals are to break even and provide a place where your family can vacation then that is completely understandable.

Patricia Andriolo-Bull · Answer

I'm not really looking at extraordinary as I wouldn't want to absorb the risk that comes with that.  I like good investments that are stable and factor in growth over time.  My properties have had consistent occupancy but continue to have growth in ADR and in property appreciation.  I cash flow and have a solid ROI especially as my stock portfolio is taking a bit of a beating right now.  I look at it as a means of diversification and income.

Scott E. · Answer

I manage 4 STR's right now for owners out here. All single family homes, scattered around Tempe and Scottsdale.

3 of the 4 are performing decent but mediocre this season compared to last. The only property that is bringing in exceptional returns is the one where the owner went "over the top" with the interior design. Finishes are A+, the furnishings are A+. No Ikea, Walmart, or Home Depot junk in the house. It feels like you are walking into a model home, and the guests can tell the difference. Also helps that the location is about as good as you can get.

The STR market has become more competitive. There are a lot of really well done properties that have dominated the rankings on airbnb. Plus developers have brought literally thousands of new, quality hotel rooms to the market over the last couple of years. Scottsdale even has a Caesars now.

All that being said it's still possible to do well as a STR investors but you need to be willing to spend more on the right location, the right design, and the right furniture. And of course you need to be a great host :)

Collin Hays · Answer

Yes, "extraordinary" is generally off the table. In the Smokies, not only has demand softened, but inventory has grown.  Owners are easily discounting 30-40 percent over a few years ago to keep their properties occupied.

Input costs have also risen substantially. Insurance premiums are way up. Utility companies have targeted rentals as ripe for new income and are charging significantly more for power to a rental cabin than a residential dwelling right next door. Property taxes have gone up significantly, as taxing authorities have figured out that all of those out of state investment property owners are choice pick'ns for more taxes, so they are levying much higher taxes on the investment properties than residential.  Municipalities have also began charging annual "safety fees" (another tax) for investment properties.

When taxing authorities - and I include utilities in that bucket since there usually is no competition and you have no choice - discovered all of the profit in the vacation rental market, they went in whole hog to claw out much of that for themselves.

That's what gubmit does, just give them enough time.

Craig Jones · Answer

EXTRAORDINARY profits are still there for folks with STRs in markets that have lots of demand, hard limits on the number of STR permits available, and 2021 mortgages below 3%.

Have the EXTRAORDINARY Profits in STR Ended?

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