Rookie Reply: Analyzing a Short-Term Rental Market

Ashley:
This is Real Estate Rookie episode number 88. My name is Ashley Kehr, and I am here with my co-host Tony Robinson and we are back with another Rookie Reply.
Today, this topic is very, very special to Tony so I’m going to let him take it away because he’s going to be the expert on this.

Tony:
So today we’re going to talk about my favorite subject of all time, which is short-term rentals but more specifically, I get a lot of questions from folks on Instagram, Facebook groups, wherever about how to choose your market. People always say, “Where do I start? How do I know where to invest?” So today I’m going to share with you four things that I look at when analyzing a potential market and this is actually pretty timely for myself as well, because we’re actively looking for a third market to start investing in so I’m going to share with you guys what it is that we look for.
So the first thing that we kind of take a look at is seasonality. There are some short-term rental markets that are feast or famine, right? During the peak season, they’re booked a hundred percent, no vacancy at all, but then during the off season, you couldn’t give it away for free if you wanted to. We like investing in markets that have a little bit more consistency and visitation throughout the year. So again, we’re in Joshua Tree, California, we’re in the Smoky Mountains in Tennessee, and the difference between peak season and off season is relatively small, right? Our occupancy doesn’t dip to 30% when it gets slow. So we like the idea of consistent visitation because it helps manage your cashflow a little bit better. You don’t have to worry about coming out of pocket or going into your reserves to cover your expenses during this low season. So that’s one thing that’s important to us.
The second thing that we look for is we like investing in somewhat mature vacation rental markets. Both of the markets that we’re in, people have been visiting those places for decades and decades before Airbnb and VRBO were ever even ideas, right? And we like that because there’s kind of this built-in infrastructure to support the short-term rental, like businesses that operate there. And there’s also, I think, people have already accepted that short-term rentals are a natural part of that market because people were already doing it before Airbnb and VRBO came along. So the mature vacation rental markets is important for us as well.
The third piece, and it kind of ties in with the second one is regulations. It’s not necessarily that we’re looking for places with no regulations, because I think if the city that you’re investing in has zero short-term rental regulations, it probably means that it’s not a mature vacation rental market because the mature vacation rental markets have already figured out how they’re going to deal with and regulate short-term rentals. So what we look for are regulations that are favorable to short term rentals, regulations that… And not necessarily easy, I don’t need a market where it’s easy to get a short-term rental permit and actually in some situations, I think it might be a little bit better to have markets where it’s harder to get a short term rental.

Ashley:
Tony, where would people find out what those regulations are for the cities? How would they research that?

Tony:
That is a great question. So Airbnb themselves, when you’re thinking about whatever city you want to invest in, they usually have some kind of legal or permit guide on their website, but you can just call the city that you’re looking to invest in and say, “Hey, who’s in charge of the short-term rental permits?” Usually it’s the planning department or planning commission. Sometimes it’s at a city level, sometimes it’s at the county level. So it depends on what city you’re investing in. But if you just call up the city and say, “Hey, I want to get a short-term rental permit,” someone in the planning department should be able to tell you what to do.

Ashley:
Okay. Awesome. Another question I had is price point something that’s important? Should people, before they even start analyzing the market, should they be looking if it’s even in their price range?

Tony:
That’s a good question and you’re absolutely right. So I guess the very, very first step you should take is understanding what your purchasing power is, right? So how much down payment do you have available? What loan amounts are you able to get qualified for? And that will kind of dictate what markets you can invest in and what kind of properties you should be looking for. If you want to go invest in a eight bedroom cabin in the Smoky Mountains, you’re going to need a million dollars to make that happen and if that’s not in your toolbox, then maybe that’s not the right market for you to go into. But if you want to buy a big house in, I don’t know, Three Rivers, California, maybe there’s a little bit more flexibility for you to do it there. So yeah, I think understanding your financing first and your purchasing power is probably a good first step also.

Ashley:
Okay. Awesome. One other question I had about that is how long should you focus on one market? Or should people be looking at three different short-term rentals and throwing in offers in those three markets? Or should you focus on one market and stick to that until you get a property, you build some properties in there and then move to another market?

Tony:
So I think what drives people to additional short-term rental markets is… There’s a couple of things. One is inventory, that’s kind of what’s driving us to look to new markets right now. It’s just that there’s very low inventory in the markets that we’re currently investing in. And for the velocity of acquisition that we want to maintain, we’re having a hard time doing it with just these two markets and we’re understanding that if we want to continue to scale, we’re going to have to add that next market. So that’s one thing to look at which is available inventory.
A second reason why people might expand to another market is the returns might be better, right? And this is kind of what we’re seeing in our markets as well, is that the prices have gone up pretty aggressively in the last six months in both of those markets. So the $50,000 down payment that we had six months ago isn’t producing the same cash-on-cash return that it was, or that it is today. So that’s another reasons that the returns might change.
And then the third reason that isn’t as apparent is the financing. So we purchase all of our vacation rentals using second home mortgages. But the limitation with that is that you can only have one in every market that you invest in. So say that you’re a husband and wife duo, or you’re two partners, partner one gets the first mortgage, partner two gets the second mortgage. After that you don’t have the ability in that same market to get the 10% down vacation home loan. So what some short-term rental investors do is okay, once they’ve maxed out their vacation home mortgages in a market, then they’ll move to the next market and just keep repeating that process over and over again.

Ashley:
So get your systems and processes in place first, before you start going in multiple markets.

Tony:
Yeah, absolutely. So there’s a lot of things to consider. And then I guess the last thing that I’d add to you, Ash, is just to look at the investability in that market as well. And we kind of touched on it, but you want to see what is the ratio of purchase price to potential income. And there’s a bunch of sites where you can kind of pull this data: Mashvisor, PriceLabs has market dashboards, AirDNA has a lot of data on these kinds of things as well. But you want to compare what the purchase price is to the projected income and see if those numbers can help you meet whatever your cash-on-cash returns are. Some people might only want 20% cash-on-cash return. Some people might want their full investment back in the first year. So it depends on you. What’s your kind of risk profile is? What your desires are as an investor?

Ashley:
Tony, what about exit strategies in these markets going in and you want to have a short-term rental? Do you look at any exit strategies besides just renting it out as a short-term rental?

Tony:
Yeah, so, I mean, there’s always the option to sell, right? If for whatever reason you feel like maybe the market’s not moving in the direction that you want it to, you can always sell it. But the way that I approach it, and I can’t recall if I shared this in the podcast or not yet, but when I buy a short-term rental, I’m buying it as a piece of hospitality real estate. It’s not a long-term rental. I’m not looking for tenants. I’m not even necessarily buying in markets where long-term rentals are even all that popular. In the Smoky Mountains, the vast majority of properties that you drive by are not long-term rentals. They are short-term rentals. They build communities of nothing but short-term rentals in the Smoky Mountains, very similar concept in Joshua Tree. A lot of the properties that you drive by are short-term rentals.
So that’s my thought process when I buy any property that we’re setting up as short-term rental is that this is a piece of hospitality real estate, not a personal piece of real estate. And when Hilton or Marriott or Hyatt go out and build hotels, they’re not necessarily asking themselves, will this hotel still work as an apartment complex? They’re not saying, “Hey, we’re only going to build this hotel if we can use the exit strategy of turning it into a big apartment complex, if it doesn’t work out.” Right? Their first and main and primary business focus is building a world-class hotel and then giving their guests a world-class experience. So I use that same kind of mindset when I’m picking up my short-term rentals also.

Ashley:
Tony, that’s really great. That’s definitely unique advice that you don’t always hear, but that works. That’s working for you.

Tony:
Yes, it’s doing all right for us. I don’t know, check back on [crosstalk 00:08:56] in a couple of years.

Ashley:
Because a lot of people always say, a lot of people preach, “Make sure you have those different exit strategies that you could flip the property, that you could rent it out as a long-term rental.” And I think that looking for markets that you’re going to be so secure that the short-term rental is going to work and always going to work is great advice.

Tony:
Yeah. I guess one of the things I’d add too, right, is that you always do have the option to sell, right? If you’re buying right, hopefully you have enough equity in the deal to where if you do need to sell, even at a discount of what the current market value is, you still got a little bit of wiggle room there. So we’ve got, in our cabins in the Smoky Mountains, we’re probably at 70% LTV right now. So even if we needed to sell at a slight discount, we should still be able to at least pay off our initial mortgage.

Ashley:
Great. Thanks for taking over that episode [crosstalk 00:09:42]. I had no value, no value.
Well, thank you guys so much for listening to today’s Rookie Reply. I’m Ashley at Wealth From Rentals and he’s Tony at Tony J. Robinson and we will be back on Wednesday with a guests and another episode.