#218 Investing in Rental Real Estate: Short-Term vs. Long-Term Rentals

Hey everyone. This week we're going to talk about a topic that I discuss, I would say on a weekly basis with people that are in our community that are interested in investing in real estate. It's short versus long term rentals. Should someone invest in a short term rental like an Airbnb or a longer term rental where they rent for the year, that sort of thing? What's better for you? What makes sense? What are the pros and cons? We're going to talk about that all today, so stay tuned. Welcome to the Passive Income MD Podcast where we talk about creating your ideal life through multiple streams of income. If you enjoy hearing about this thing, make sure to hit subscribe. Now, let's get on with the show. Now, on this podcast and in our community, we talk a ton about active versus passive real estate investing in our world. What that means is that when you invest actively, you own the real estate yourself. You are a landlord, you own it all on your own. You are responsible for making sure that property does well. It's all on you, but you reap all the rewards of it as well too. When we talk about passive investing, we're talking more about investing in someone else's deal. Now there are pros and cons to that. You're investing in someone else's deal and leveraging all of their time, expertise and knowledge for your benefit. At the same time, you have to pay someone to take care of all that. Now there are pros and cons to both, but that's not what we're going to be talking about today. Today I'm assuming you're investing on your own or you're at least thinking about it. And you're thinking about whether you should invest in a typical type rental or whether you want to venture into short term rentals, Airbnbs, which you've probably heard a ton about. Now, the market keeps changing on both of these things. We know that there are distinct differences between the two. We're going to talk about what they are, how they function from an investment perspective, and again, the potential pros and cons of choosing. Now, when I first started investing in real estate, short term rentals was not really a thing. All we talked about was how to buy a rental property, understand how to get good return on investment, the cash on cash, and ultimately how to work with tenants and property management. Now that's still important for me today because I still own a bunch of my own properties. I still own a one bedroom condo with my wife where we lived during residency when we first Got married and since then we bought some apartment buildings and then we've also invested passively in other people's deals. A few years back I actually sold one of my properties that was a mixed use used property where there were residential units and then below there was a few commercial spots. I sold that because I was really interested in buying a short term rental property. Now what is the short term rental? Usually they're for stays of one to 30 days. Usually they're known as vacation rentals or Airbnb properties. For example, a beachfront condo rented out during the summer for a couple weeks. Maybe you've gone on a trip, raise your hand or people out there acknowledge if you've ever used an Airbnb you to stay for yourself, your family. Now we know there's distinct advantages and disadvantages to doing that for your shown stay versus a hotel. But we all know with the advent of technology, Airbnb, VRBO, HomeAway, all of these type of things, that the short term rental market is here to stay and that it opens up the possibilities for you as a vacationer to have different options. What that means is that there's an owner on the other side that gets to take advantage of that. Now, long term rentals, usually they span a year or more. They cater to, you know, stable tenants that want the typical housing, apartments, that sort of thing. Example would be a family or young professional couple renting a home or renting a condo or an apartment for a year. Now, just so you know, there's something called a midterm rental which usually focuses on between that 1 month and 12 month stay. I'm going to talk about that in a future podcast. You know what those are. There's some balance of flexibility and stability for both landlords and tenants in that type of case. But again, that's for another day. But for now I want to talk about how the short and long term rentals compare real quick when it comes to certain key areas. Let's talk about the returns. Short term rentals often yield higher returns per night, perhaps higher cash flow. However, you have to deal with higher vacancy rates and turnover costs. The key thing to remember, short term rental is not like your typical long term apartment building. You are in the game of hospitality. So again you're going to charge more per night, you have to deal with more headaches, you, but in return for that, there's typically a higher cash on cash yield a higher return. Now long term rentals, they provide that steady predictable income with lesser night rates. When you average it over a Whole entire year, but you get the stability of having one tenant in there for that whole time. I would say when you compare the cash on cash, and that's calculated by taking the amount that you got in terms of return, in terms of investment over the amount that you invested, is a quick way to estimate yield. Short term rentals, when optimized, typically get a higher yield than long term rentals. But again, it's because you're a different asset class, you're more of a hospitality type feature and you've got to deal with the risks and the pros and the cons of that. Now, when it comes to property management and property management fees, short term rentals definitely have a higher property management fee. Due to the frequent turnovers, guest services, the many situations that they have to deal with on a monthly basis, you often might find those property management fees run anywhere between 20 and 30% of the gross income income or gross revenue of that property. Now, long term rentals generally have lower management fee that usually decrease with the number of units. There's still oversight, but not the constant day to day that a short term rental might require. So depending on number of units that you have for the long term rentals for property management, you might have a fee of 5 to 10% of the gross income.

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Now back to the show. Now, if the returns on the short term rental might be higher, why would anybody not do short term rentals? Why wouldn't they all do it compared to long term rentals? Well, there's a little thing called risk. Short term rentals, they face that risk of seasonal demand fluctuations. There are regulatory changes, there are political issues. Short term rental laws change quite a bit. They might also be more sensitive to the current economy. We all know that people tend to travel less, especially in high value destination areas. In times of recession or when the economy's bad, there's always a chance that you get tenants in there that just break stuff. So there's bigger maintenance costs. And to go back to something I just said, the biggest risk in all of short term rentals is regulatory changes. Meaning that the area decides that they don't want short term rentals anymore, or they have a certain amount of permits that they want to give, they change their policies. It's happened all over the place. Maybe you've heard of that. Especially in certain areas of the country where a lot of people have their own homes, they don't want short term rentals around, so they try to create regulations around it to block all of that. So you have to be completely aware of that whenever you decide on a short term rental. That's the first thing that I tell people to look at, is that place protected from a regulatory and political standpoint to make sure there's a sustainable short term rental property for the long term. Now, long term rentals also have their set of risks. If you got a tenant in there for a year and they decide not to pay, there's tenant defaults. There are market shifts as well that impact rental demand. Turnover might create long periods where there's a ton of vacancy that you can't do much about. There are also some political regulatory risks when it comes to evictions and eviction memorandums, increase in rent caps. So the key is to understand the risk of each individual property, to understand what they are when it comes to taxes. There might still be a lot of similarities between short term and long term rentals. But when it comes to taxes, there are significant differences. The short term rental income, since it's less than 30 days, it can be taxed as ordinary income. It is a business. Again, it's like you're in the hospitality business. Please talk to your CPA about this to confirm. But there are some deductions that you can take like cleaning and maintenance. One of the greatest things about short term rentals is something called the short term rental loophole. This is a tax loophole. Since this is an active business, it's possible that if you hit certain qualifications, it's possible that you as a short term rental owner can take the losses or paper losses on this rental property and offset some of your active day job income. Now, as a doctor, that can be extremely powerful because we all know that when you buy rental property and do something called cost segregation and depreciate the asset, that you can create massive losses on paper for that property. And if you could offset a couple hundred thousand dollars off of your day job income, that can cause a significant reduction in the amount of taxes that you owe. Again, talk to your CPA to see how this works. Now, on the long term rental side, it is seen as long term passive income. So it's taxed in a completely different way than short term rental income. You can still get depreciation, you can still take deductions, you can still take that. Again, it's long term capital gains. However, in order to offset some of your day job income with the paper losses from this long term rental, you have to actually become a real estate professional. Now we've talked about that in previous podcasts. You have to hit certain qualifications like you have to work on your long term rental more than your day job. You have to have a certain number of hours qualification and that can be tough for a lot of people with normal jobs to qualify. But there's no doubt that there are benefits to taxes for both. That's real estate in general. But specifically for each one, it's important to understand the different benefits. Now, you don't want to decide on the rental just based on tax benefits. We talked about not letting the tax tail wag the dog and I've made that mistake before. But it is an added bonus when you start putting the whole picture together. Now, how about when it comes to time commitment and hassle factor? That's one of the biggest considerations when it comes to owning your own property is how much time and energy and effort are you going to be dealing with these properties. Now, with short term rentals, there's definitely higher demand. There's frequent management issues that happen with these properties every day. They're dealing with guest communication, cleaning, turnovers, damages. There's a ton of marketing and those are considerations that you want to have as an owner. Even if you have a management company, you want to make sure that you manage the asset to maximize and optimize the benefit from it. So yes, I'm outsourcing. A lot of the toilet calls, the problems with the pool, whatever it is, problems with Internet, all of that, I'm outsourcing to my management company. So when it comes to certain things like how should we furnish the property, should we add a water slide, some major expenses and issues, that's all on me. When it comes to things like marketing or social media, honestly, I take on most of that. Is that something that you want to do? And when it comes to long term rentals, probably requires a little less immediate attention. But when it comes to things like turnover, the major costs, do you need to replace the H VAC system, do you need to repair the roof and things like that. That happens with short term rentals as well. But a lot of those are major considerations when it comes to long term rentals. Of course, you got to deal with tenant selection and property maintenance. Those are things that your management company can definitely help with. But the thing I want to stress and the thing I've learned over time, if there's one thing you take away from all of this, is that whether you own a short term rental or long term rental, you own the property yourself. You are responsible for the direction of this property. Property management, I found, is great for solving some problems, but they're not great for having vision for coming up with major solutions to optimize these properties. That's something that you can't truly outsource. So which one of these sounds more attractive to you? What makes sense for you? I own both of these. The one thing I didn't mention for my short term rental is that I get to use it once in a while. And that's a lot of fun for me. We have a property in Indio, California. It's near the Coachella Festival. But there are a lot of fun things for the kids to do as well. They love having that as a second home that we can drive to every once in a while just to use. Now I try not to use it during the major periods because I want it to still bring in a lot of income. But when it's being unused, in particular for a weekend, sometimes we'll head out there and that's an added benefit of the short term rental. Now, before you decide to go either way, the important thing is to do your own due diligence. Educate yourself on both of the pros and cons and the benefits and downsides to both Understand your individual investment goals, see what fits, figure out how much capital you have, and decide which one makes sense for you. Could you do both? Absolutely. Now, if you like discussing these things, make sure you join one of our communities. We have Passive Income Docs Facebook group in particular that is available to all physicians. We love talking about this stuff. Get plugged in. Find other people who have your similar interests. Make sure you join us at our conference, the Physician Real Estate and Entrepreneurship Conference where we talk about all of these things and I thank you for listening today. You're amazing. Have an awesome weekend. Let's talk again soon. Enjoy the show. Let me know by dropping a review in the podcast app you're listening to us in. And if you haven't already, make sure to hit subscribe. Join thousands of physicians who are also on this journey to creating their ideal lives through multiple streams of income. Learn more at our website passiveincomemd. Com. Thanks again for allowing me to be.

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See you next time.