If you want to get into real estate investing but aren't sure where to start, renting out a vacation home can seem like an obvious place to start, but is it a good investment?
Vacation rentals are a popular investment vehicle for many people for a few reasons. They can offer consistent income, a fun place to stay, and the potential for capital gains.
But before you spend a fortune on a vacation rental, you'll need to understand if it's a good investment, or if other investment options are stronger.
In this post, I'll answer the question, are vacation rentals a good investment, other real estate investing alternatives, and much more. Let's get started!
What is a Vacation Rental Property?
A vacation rental property is a real estate investment that doubles as a vacation home in addition to an investment property.
This can be a good investment strategy if you're looking for something to generate monthly cash flow in addition to providing you some downtime to rest and relax.
Vacation Rental Property Benefits
Additional Rental Income
When purchasing a vacation rental, you can rent it out and earn passive income from your property.
Many vacation rental properties can produce great cash flow – which can be beneficial for your finances.
Before opting to purchase any vacation rental investments, it's a good idea to take a look at the cash flow and income projections to be a better understanding of the returns you can see.
To do this, you'll need to analyze the costs that come with owning the home, like a mortgage, property taxes, insurance, and other expenses.
You'll also want to take a look at the local rental market to get a solid understanding of the approximate rental income you might be capable of making.
Rental income can be difficult to assess because each property is unique and the rental market can vary greatly from place to place.
Try to find 3-5 rental properties in close proximity to yours which similar square footage and amenities to get a baseline rental price.
The amount of rental income you can make will also depend on how you rent your property. I'll explore your options below!
By owning a vacation home, you have a few different options if do choose to rent it out.
For example, you might consider a short term rental option where people can rent your property for a couple of nights or the entire week.
By using sites like Airbnb or VRBO you can reach a large audience of people searching for a vacation rental home. Short-term rentals can often make the most money, making it an attractive investment option for many people.
However, short-term rental properties require a large amount of upkeep and work to maintain. Because you'll have a consistent flow of guests coming to and from your property, it can be a headache for some investors.
To alleviate the amount of work and stress, many short-term rental property owners will hire a property management company to do the work for them, but this can cost around 25% of your rental income.
Another option is to rent it out for an entire season. This might be 3 to 4 months out of the year.
With this option, you won't have nearly as much maintenance and headache because you'll only have a few guests a year. You can still choose to hire a property management company, but they often charge much less for these rentals.
Or you could rent it for the entire year with a traditional rental agreement. This will typically offer the least amount of rental income, but is the least amount of work and headache.
When it comes to real estate investing of any kind, there are some tax advantages you'll want to consider.
Because your vacation rental is likely to have maintenance expenses, mortgage interest, and high insurance premiums, you'll be able to deduct many of these expenses from your rental income.
Another common tax benefit is depreciation. Depreciation is a deduction you can take on the value of your rental property each year.
This deduction allows you to slowly write off the cost of your rental property over a period of time, typically 30-years. If you do take this deduction, you'll have to pay back the taxes if you sell your vacation home in the future for a gain.
This can help to reduce your taxable income, and can result in a larger refund or a lower tax bill come April.
Be sure to talk to your accountant to see what deductions and tax benefits are available to you and how you can best take advantage of them.
Save Money on Vacations
If you decide to purchase a vacation property, you can also use it for yourself during certain times to save money on your own vacations.
Depending on the type of rental you choose, you could block off certain times each year to use the vacation home for yourself.
For example, if you choose to do a short-term rental, you could block off a few weeks each summer to use your vacation home.
Another way to make money with an investment property is through appreciation.
When you buy physical real estate like a vacation rental investment, there's a good chance it will increase in value over time because it is an appreciating asset.
The exact amount it will appreciate is unknown, and never guaranteed.
However, it's common to see the housing market increase anywhere from 1% to 2% a year. While this might not sound like much, this could amount to $7,500 to $15,000 a year for a $750,000 vacation property.
Potential rental income in the future is much higher than it is today.
When deciding whether or not to purchase a vacation rental property, it's important to consider the future income it can make. Depending on vacation rental demand, it could be much higher than it is today.
Don't worry – we hate spam too. Unsubscribe at any time.
Vacation Rental Property Disadvantages
There are also some disadvantages that come with owning a vacation rental property that you'll want to consider.
More Money Needed for Down Payment
If you're planning to get a second mortgage to fund your vacation property, you'll need a larger down payment than a traditional mortgage.
Whereas it's possible to obtain a primary mortgage with just 3.5% down, you'll need at least 10% down for a conventional second mortgage.
On a $750,000 home, that's $75,000 needed upfront to purchase your vacation rental.
Higher Interest Rate
Along with a large down payment required, you'll also receive a higher interest rate on a second mortgage for a vacation rental.
The interest rate will depend on current market conditions, but it's common for second mortgages to come with interest rates around .25% to 1% higher than a primary residence.
More Maintenance Expenses
Maintenance costs are a part of owning any home, including vacation rentals.
There are many common maintenance expenses that you'll have to complete on a vacation home.
For example, roof replacements, HVAC troubleshooting, and other repairs are going to occur with your vacation property, so you need to be prepared.
While the monthly rental income you receive from owning an investment property can certainly be nice, it does come with a cost.
Vacation rentals can include a lot of headache when compared to other investments like the stock market.
For example, if you want to find tenants for your vacation rental, you'll need to do some marketing and show the property.
Whenever making any investment, there is a certain level of risk involved.
Most vacation rentals will be occupied by families or teenagers looking to get away for a weekend, which means there is always the potential for something to go wrong.
Depending on the type of rental you choose, you might have some protection from platforms like Airbnb or VRBO, but off market deals will require you to take on the risk yourself.
If your tenants break something, you'll be responsible to replace it. While there might be a security deposit, sometimes the damage can be more than the deposit is worth. In this scenario, you have the option to press legal charges, but that could lead to a lengthy and costly legal battle.
How Much Money Can You Make with Vacation Rentals?
The amount of money you can make with vacation properties will depend on the vacation rental market in your area and the price of your home.
The vacation rental industry is expected to reach over $20 billion by 2025, meaning there's money to be made.
Depending on your vacation property market, it's possible to make anywhere from $500 to over $2,000 per month from a vacation home.
Additional Factors of Buying a Vacation Rental
Here are a few considerations that you should take into account before investing in vacation properties.
How old you are plays a big part in deciding what decisions to make in life, including deciding whether or not owning a vacation property is right for you.
If you're younger, you might not have the time to use your vacation home as much as you'd like, but in a decade – it could be money well spent.
If you're older, you might have plenty of free time to use your vacation rental, but you'll want to make sure you have the money to cover mortgage payments, property taxes, and maintenance costs.
Laws & Regulations
Depending on the location of your vacation property, you might not be capable of renting it out short-term.
Local laws could prevent you from renting out your property for less than a week, which could significantly reduce the number of people who are interested in booking your home.
Type of Vacation Property
While many people think of a vacation home somewhere where the weather is warm and sunny, like a beach house, there are other vacation properties to consider.
For example, finding a property next to a popular ski resort could be a great investment.
Think about what type of activities your guests will enjoy and choose a property that caters to that.
Tips to Owning a Vacation Rental
If you're passionate about owning a vacation rental, here are some tips to get you started.
Research the Area
It's important to do your research and find an area that is in high demand for vacation rentals.
This will ensure that you can charge a higher price and have less vacancy rates.
When searching for vacation homes, take a look at crime maps, tourist information, and the average rental prices in the area.
Hire a Property Manager
A property manager can take care of all the day-to-day tasks of owning a vacation rental for a fee.
This could include screening tenants, collecting rent, completing repairs, and more.
While many people baulk at the property management fees, I see it as money well spent to have less stress when investing in vacation homes.
Depending on the type of rental, it will cost anywhere from 10% to around 25% of your vacation rental income.
Finding a great property manager can take some time, but you'll want to be sure your property is in good hands.
Become a Realtor in Your State
Becoming a realtor in the state you plan to purchase your vacation home in can save you tens of thousands of dollars.
It's common for realtors to get a 1.5% cut of the selling price of the home. This means that a $750,000 home would net you $11,250. It might cost a couple of thousand dollars to get licensed, but this is money well spent.
Use a Vacation Home to Diversify
Owning a vacation home can be a great way to diversify your income and investment portfolio.
Investing in vacation rental properties can help to ensure your money isn't being stored in a single asset class.
If you have many other real estate investments, vacation rental investments can help to reduce the risk associated with any one property.
Form an LLC
Whenever buying a vacation rental, it's smart to form an LLC that holds the property to protect yourself against any legal issues.
By doing this, your personal assets (like your primary home) are protected in the case that the LLC is sued for some reason.
Alternative Real Estate Investing Options
If you want to diversify your portfolio, using a variety of real estate assets is a good idea. Below are some great options to start investing in real estate.
Fundrise is a great investment option if you want to invest in real estate without the stress and headache of dealing with individual properties.
The platform has been around for over 10 years with a proven track record of delivering results to investors.
With Fundrise you can invest in a variety of real estate assets to help grow your money. It works by pooling money from many different investors so you can purchase large assets that you wouldn't have access to otherwise like apartment buildings.
As a bonus, you don't need much money to get started and they're giving new investors $10 completely free. Check out my comparison of rental properties vs Fundrise to learn more!
Invest in Commercial Real Estate
Commercial real estate is another option for those looking to invest in real estate.
This includes office buildings, malls, and other types of retail properties.
Invest in REITs
Real estate investment trusts make investing in real estate easy. These are traded on the stock market and allow you to invest in a variety of real estate assets with just a single purchase.
Acorns is giving new users $10 completely free, so create your account with the link below!
Final Thoughts on Owning a Vacation Rental Property
Buying a vacation rental property can seem like the perfect investment for many people, and it certainly can be.
Owning a vacation property can come with several benefits like the ability to earn rental income, deduct operating expenses when you pay taxes, and being able to enjoy your home whenever you want.
Vacation rentals can be great investments when used correctly to balance your investment portfolio and supplement your income.
Have you owned a vacation rental? I'd love to hear your thoughts. Tweet me @DntWrkAnthrDay your experience.
Don't worry – we hate spam too. Unsubscribe at any time.