Lease Arbitrage Deals Just Got Riskier | The STRR Podcast #103 | Tim Hubbard

So I talk a lot about the upsides in real estate and short term rentals, and that's because I'm super bullish and I think it's got a lot of room to run, especially if you're in the right market. But there's a couple areas that maybe we need to be a little more careful about. One of those is lease arbitrage. There are some more potential downsides that I want to bring up this week. Welcome to Short Term Rental Riches, where we'll discuss investing in real estate, but with a specific focus on short term rentals to help you build wealth faster with as little headache as possible.

So if you guys have been listening to the podcast for a while, you know that I mainly own all of my properties, but I did do a lease arbitrage deal with 10 apartments. It's actually working out very, very well. Although we have had a few issues and I was watching a popular YouTube channel Airbnb automated recently. Not sure if you've seen it, but a guy named Sean runs it and he exclusively does lease arbitrage. So he knows this much better than I do. I think he has over like 100 properties or something. And so he has good advice on the operational side on how to run lease arbitrage deals. Now, he's not investor in these properties, and as you guys know, I am an investor at heart, and that's what we talk about almost exclusively on this channel. But I did happen to do this lease arbitrage deal and he brought up some good points as to why lease arbitrage might not be looking so bright in the future. So I want to talk about some of those main points, a couple of which are actually sort of affecting me right now with my lease arbitrage deal. So let's just jump into the first one. What happens if a landlord doesn't fix big maintenance issues? Well, we can have this in our lease, right? And I hope that you do if you have a lease arbitrage deal out there. But even if we have it in the lease, it doesn't mean that the landlord is going to fix it like overnight. I can tell you this property that I lease, these 10 units, it's in a really cool historic building. It was like 90% renovated, but the part that wasn't renovated, well, we're having a couple challenges with. And it's getting delayed, and it's getting delayed and it's preventing us from being able to rent some of the units. I don't know when they're actually going to be able to be rented out. There's some noise issues and stuff like that. The good news is I have a good relationship with the owner and so I'm not paying for those leases while I'm not able to rent them out. But this has taken a long time. And now if you're in a lease deal with an owner that maybe isn't so easy to work with, it could kind of run you out of that deal. Right. So we can kind of relate this to rent control. If you've studied rent control before, you know, it usually doesn't work out. And yes, they did just assets statewide in California, which is where I'm originally from. But a lot of times what happens with rent control is that if investor, a landlord can't raise their rents and they have a tenant in there that's way under rented, well, they stop fixing things. It's a way for them. Well, first of all, they're not making as much money, but it's also something that they might be doing in hopes that the tenant moves out so that they can raise rents. So it's not good for either side. And when we're doing these lease arbitrage deals, we're locked into a lease rate, right? And a lot of these lease arbitrage deals, like the one I signed, is seven years long. That means if the landlord or the owner thinks that he's missing out on a lot of rent, well, then maybe some of these similar things might start happening. So we can of course cover some of these maintenance expenses. And I actually have that in our lease that, you know, if it's under $200, we're going to fix it because we want to get it fixed as soon as possible so that our guests are happy. But there's only so far we can go with that before it starts to eat into our returns. Right. So that's a big issue that you might encounter is just issues with the property and a landlord maybe not wanting to fix them. Now another one that might come up. And as property prices are booming because we've printed so much money and asset prices are getting higher and higher, a lot of landlords would like to refinance their properties and pull cash out. We've talked about cash out refinances before, but you can't cash out, refinance a property that's not leased up, right? So if a landlord comes along and someone says, oh, I want, I would like to lease all of your apartments, well, that's a way for them to lease them up really quickly. The rent's coming in regularly and a bank's probably going to be comfortable or more comfortable providing them a new loan because that property is fully occupied. Now what if hopefully this doesn't happen? But what if the landlord really just wanted to lease that property up so he could cash out refinance and then he doesn't really care what happens afterwards? That could kind of go downhill, you know what I mean? So hopefully that's not happening. This third one we talk about a lot and that's if the laws change in a city and you don't have it in your lease, you, you don't have that as an out in your lease. So for example, if so and so city comes along and says you can't do lease arbitrage and you're still required to pay that lease and you don't have that out in your lease, well, gosh, you're going to be, you're going to be in trouble there. So we did a, we did a episode a while back about some of the things that I highly recommend putting in your lease arbitrage deal if you're going to do that. I have this clause in our lease and my lease. So one other thing that's happening here in the real estate world and that is that rents are going up. They're going up really quickly right around the nation. We've talked about this as well, actually an average of over 10% nationwide, some cities as much as 30%. So if you're locked into a long term lease, that's great because that means that your arbitrage, the difference between what you're leasing the property for and what you're very likely able to release it or sublease it out to, to short term rental guests is probably going to be higher. But what happens when that lease runs out? If it's only a year or two year from now and your landlord wants to jack Your lease up 20% if you're not in a lease, well then they can do that in most states. Some states have restrictions around that. But what's going to happen at the end of that lease? Well, the one that I signed is seven years I'm already making, I've already got all my money back basically and it hasn't even been a year yet. So it's working out really, really well. But I incorporated two lease increases in my seven year term, two 3% rent increases, which means at the end of this seven year term I'm going to be renting those apartments for way, way, way less than the market value. And what is the landlord very likely going to want to do? He's going to want to jack them way up, right? So the end of this seven year lease could very well be the end of my lease arbitrage deal, but I'm prepared for that. Like I said, the reason I got it in this deal is I already had the operations in place and we've talked about that before. Lease arbitrage deals are operated just like a normal short term rental for the most part on all the guest relations, everything in that sense. So I think they can be really good. There's just things that we have to be careful of. And with rents rising like this, maybe they're not going to be as lucrative as a lot of us maybe wanted them to be. So lastly, again, I got some of these points from Sean on Airbnb Automated. He does have a lot of good content on his YouTube channel, so check it out if you haven't already. And he said that he's making about 25 to 27% on his money. Now, I can tell you I'm making more than that.

And yes, there are barriers to entry to purchase your properties and I realize that that can be a bit of a hur hurdle. But this is a long term strategy. Owning the property is a long term strategy. If the rules change in the city, I can go back to long term rents. If the rents rise really high, well then good for me, good for all of us that actually own the property, because we can charge higher rents. So I'm actually making more than the percentage that he quoted. And that's not even including the fact that we can do these cash out refinances. So some of these properties I've zero dollars in and they're making a lot of money, so the returns are really good. I'm not saying lease arbitrage doesn't have a space in your portfolio or if you already have the operations set up and it could be a really good way to get started. Just keep in mind the future outlook maybe doesn't look as bright as it used to. And you've got to think in the very end of this is, is this a long, long term solution? We know it's not really an investment, right? We're not, we're not actually owning anything. If you stop leasing those properties, well then you're going to stop making money. Whereas if you own the properties, you're going to continue have tenants in there, you're going to continue to build wealth. So that is the ultimate goal. I know it's not super easy to get into that. We've got that initial hurdle of coming up with our down payment, but you can definitely do it if you haven't yet. So just want to bring up some of these points and, and I don't want to intimidate anyone from getting the short term rental world because I think it's fantastic. I'm super bullish on it. And so until next time, have a wonderful day.