As an alternative investment fund operator and general partner on my own deals, short-term rentals (STRs) have historically been a no-touch zone for me. Our fund prides itself on income stability, and the fluid nature of changing regulations has always served as a natural barrier to adding this asset class to the current mix in our income fund.
However, as someone who prides himself on being versed in multiple asset classes, STRs have been on my personal investment radar for some time now. I usually approach any new asset class with a 2-year horizon, and STRs are no exception.
This window provides enough time for three things to occur:
- Investment fads die out on their own.
- I gain a thorough consensus on the viability of the asset from my network.
- I do my own research on any nuances that come up during my networking recon stage.
After the 2-year horizon, it’s time for me to invest or take the asset off my list.
A Bad First Impression
To be fair, STRs aren’t exactly new for me. More than 10 years ago, I purchased a vacation home in a gated community 2.5 hours away from me in the Pocono Mountains. While the original intent was purely to be a getaway for our immediate family, it quickly became apparent that the home was being underused with less and less frequent visits. A year or two later—right around the time that Airbnb was starting to take off—I realized there was an opportunity to rent out the house as an STR.
The results were mostly negative. Since we were accidental STR investors at that time, we had no systems in place, such as a dedicated cleaning or maintenance person, pricing strategy, and STR-friendly technology like automatic locks. That meant that either I or a family member had to drive hours both ways to open the house, and then do it again a few days later to clean and fix any mess that was created during the tenants’ stay—all for a measly $100/night. The outcome was predictable: We quickly got tired of this model and switched to long-term rentals.
I took away a few key lessons from that experience:
- Timing Matters — 10 years ago, the STR market was much less mainstream than it is now. With the increasing popularity came tools like automated locks, which have revolutionized the industry.
- Scale Matters — One rental property 2.5 hours away makes it hard to incorporate professional help in running your STR.
- Size Matters — A 2-bedroom/2-bath house will only attract a small group, while a larger property can command a higher daily rate.
- Experience Matters — Knowledge is power when it comes to investing in STRs, and our lack of experience doomed us from the start.
- Data Matters — Sites like AIRDNA provide fairly accurate rental rates prior to ever listing your property. That type of data allows an investor to underwrite with more accurate projections.
- The Business Plan Matters — STRs tend to have seasonal flows to their revenue. The ability to extend the season through a solid business plan can turn a good deal into a great one.
Today’s STR Industry
Given my previous failure, I was initially hesitant to jump back into this asset class, but that changed roughly 2 years ago, when I first put STR back on my investing radar—or, more accurately—my network forced it back onto my radar. At first, there was a small percentage of investors that recommended the asset class, but those numbers just kept increasing. What impressed me most was the wide variety of ways investors were incorporating STRs into their investment portfolio—from turnkey operators that manage every step, to passive investments with operators that specialize in the space, all the way to investors who do everything themselves.
Even more attractive to investors was that some STR models do not require purchasing the underlying asset. Instead, the model works by arbitraging the difference between the long-term rates a tenant would pay and the difference in rent collected from STR rentals. A quick example is if you can rent an apartment in Manhattan for $3,000/month, but if you put it on Airbnb, you can collect $6,000/month in rent. That difference is the rental arbitrage, and it can be scaled rapidly. Your only true costs are the costs of getting into the apartment and your furniture. But there are two big negatives with this strategy. The first is that if the lease is not renewed the following year, you have to start all over somewhere else. And the second is that you don’t build up any equity in the property.
The Contingency Plan
What scared me most from my repeated conversations was a common lack of exit planning. Usually, the investor would underwrite based on the best-case scenario and not consider what would happen if the model didn’t work. For example, can you break the lease in the arbitrage example? Can you convert to long-term tenants even if it’s not as profitable? The last thing you want to do is pay a premium for a model and not have an exit route if things go bad. Ideally, you want the numbers to work if the worst-case scenario fails, not if the best-case scenario happens.
Embracing the Model
I’m happy to report that I have come full circle regarding the STR model. After shaking off the original bad taste my failed investment left me, I realized that in a hot market, STRs can be a powerful weapon in acquiring great properties that would otherwise be out of reach using traditional underwriting, especially if the deal has multiple exit plans. Take, for example, a beach cottage community I am currently investing in and operating. Going in, the partners knew that if the STR model didn’t work, we could convert the units to condos. And if that didn’t work, we could convert them into long-term rentals at market rate, with each model producing a lower and lower potential return.
While it’s not ideal to switch your business plan multiple times during the life of an asset, that’s certainly a better place to find yourself than not having any other options. So, when done right, STRs can serve their purpose in a well-diversified portfolio.
Denis Shapiro is an alternative investment expert who specializes in apartment buildings, note funds, life insurance policies, tech startups, ATM funds, flex spaces, and hard money loans. He started an investment club for accredited investors in 2019, followed by the launch of a professionally curated multi-asset income fund, SIH Capital Group, in 2021. Learn more in his book, The Alternative Investment Almanac: Expert Insights on Building Personal Wealth in Non-Traditional Ways.
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