Tim Hubbard explains lease arbitrage—leasing units with landlord permission to sublease as short-term rentals—and focuses on the most important lease protections to negotiate. Key recommendations: include an opt-out clause tied to financial performance (example: exit if occupancy and rate thresholds cause losses for three consecutive months), an opt-out for regulatory changes, permission to change locks and perform renovations, negotiate multiyear terms (example: 7-year option with 3-year initial term and staged increases), and add liability insurance naming owner as additional insured. Also emphasizes conservative budgeting for fixed and variable costs (utilities, housekeeping, supplies) and running break-even occupancy/nightly-rate calculations before signing.
Questions this video answers
Occupancy and nightly rate thresholds such that if performance falls below break-even for three consecutive months, they can exit the lease penalty-free.
An option covering seven years: an initial 3-year term followed by another 3-year term with agreed percentage increases, totaling seven years of options.
Chapters
Last week we talked about some negotiating terms for the actual cost of our lease arbitrage, which is leasing an apartment to sublease on Airbnb or VRBO or as a short term rental operation. But there's some really important things that we need to consider before we do this and we need to have these things in our lease. And that's what I'm going to talk about this week. Stay tuned. Lets jump right in. Welcome to Short Term Rental Riches. Quick actionable ideas to help you along your real estate investment journey, but with a specific focus on short term rentals. How's everyone doing out there? I hope you guys are doing awesome. Fantastic. I hope your short term rental operations are growing and growing smoothly and you guys are getting things figured out and you're having a lot of success with this. I think it's a really exciting industry and, and there's so many ways to handle it and there's so many ways to make money from it. This week we're talking about lease arbitrage, which is another way to make money from short term rentals. Essentially we're leasing an apartment where we have the landlord's permission to sublease it on a short term rental basis or on a nightly basis to short term rental guests. And by doing so, we make the difference between what we pay for our lease to the landlord and what we're able to rent it out to our short term guests for. And that difference is the arbitrage. And hopefully that difference is really, really big. So we're making lots of money. So if you didn't listen to last week's episode, I talked about a deal that I just signed for 10 apartments that I'm really excited about and I believe have a lot of difference or spread between the lease amount I signed for and what I'll be able to sublease them for. But we have to be really careful with this because what happens if our projections are wrong? Are we stuck in the lease forever, losing money every month? Well, we want to avoid that. And if last year and all this Covid has taught us anything, it's that we need to be ready for, for uncertainty and we need to have backup options. So I want to break down some of the main points this week that we included in our lease before we signed it to protect ourselves from the downside. So let's just start from the beginning here. The main and probably most important thing that you need to have in your lease if you're doing lease arbitrage is, is an out. Yeah, you need to have a way to get out of the lease if it doesn't work. If the city changes their regulations, you need to have an out in your lease that says we can exit the lease without penalty. But you also need to have an out in case your financial projections are off. If you're losing money each month, you don't want to be in a long term lease, obviously. So not every landlord is going to be open to this. But I would really suggest if you're negotiating a lease and they're not open to it, I personally wouldn't feel comfortable with it if I didn't have a lease or way out. Unless I maybe had a bunch of leased properties already in the city. No, I take that back. Just ask for the out and then you're going to protect yourself on the downside. And the way we did this, which made it fair for both sides. So the owner doesn't want to have an out in his lease. That allows us to exit the lease without penalty just for whatever random reason. Right. They actually need some proof, some evidence that it's not working out for us. So the way I negotiated an hour lease was based off an occupancy percentage and a nightly rate. So of course you need to run your numbers on these properties. If you're planning on leasing a property to sublease it, you need to come up with rent comps, you need to come up with utility costs, housekeeping costs, all of these things, just like you would with a long term rental. And after you do that, you can calculate a break even point, a point where you need to have a certain amount of occupancy at a certain nightly rate to pay for all your fixed expenses. So your fixed expenses are going to be your lease, any short term permit fees you may have, any fixed management costs you might have if you have someone else helping you. But there are a lot of variable costs too, and those are going to be things that change every month. So that's probably going to be your housekeeping costs, the costs associated with your supplies and your toiletries.
Those will be things like utility costs, electric and water bills. You need to calculate a buffer in there before you agree to terms. But that's what I did. I came up with an occupancy rate to where if it dropped below that, I'm very certain that I'm losing money. And we also put in the lease that if that happens for three months in a row, we can exit the lease without any penalty. So calculate those numbers as best as you can think of all of your expenses that go into this, housekeeping, operations, taxes, toiletries, supplies, all of these things, miscellaneous maintenance, repairs. You want to be really conservative with your numbers before you sign a long term lease. So that's the number, that's the number one. You got to have an out for poor performance to where you're losing money, you can get out, no issue. You also want to have that out in case the regulations change. But now aside from that, there's quite a lot of other things that you'll want to have in there that are going to make the whole process a lot easier. You want to have some terms in there that allow you to change the door locks. If these apartments or these homes or whatever you're planning on leasing have the old school keys. Well, we know we need to get rid of those automatic locks, digital codes. That's one of the beginning steps to managing our short term rentals. Right. So you want to make sure you have that in the lease that you can change those. And along those lines, are you planning on doing any sort of renovations or interior repairs or anything like that? You want to make sure that the lease allows you to do that as well. Now, another big point of the lease is the term of the lease, how long it's going to be. Right. I negotiated seven years. I have the option to rent these apartments for seven years, but the initial term is only three years. And then it's going to increase by a percentage that we agreed on for another three years. And then at the end of the second set of three years, it'll increase again. So I have it for seven years. I feel pretty comfortable with that. You don't want to sign a one year lease and buy thousands of dollars of furniture to avoid the risk of something happening at the end of the lease, landlord changing his mind or, or whatever it is. So try to negotiate a long lease with low rental increases, but also that still has that out to protect you on the downside. So a lot of landlords might think that, you know, lease arbitrage is just not a good idea. They're scared of parties, they're scared of extra liability, things like that. But it can work out really well for someone that knows what they're doing or that's willing to put in the work to set up their operations professionally. It can work out really well for both sides. But you do need to have additional insurance. For this deal, we added another liability policy that adds the owner as an additional insured. It's not super expensive to add a liability policy. You can Check with a company called Proper Insurance, but also just check with any commercial insurance broker that does commercial liability policies and that will help you get some estimates and costs there. So the beautiful thing about this, you know, you guys know that I'm all about owning property, investing in property because it builds wealth. But this is a really good way to build a lot of cash flow without as much money up front. So your down payment or your deposit and your furniture costs and first month's rent and then you're on your way, you're rocking and rolling. So it's a great way to get in if you're not in the position to buy property yet. And it's also a great way to get your whole business set up because these same operations that we're using we can use for our own properties that we own as well. So I'm really excited about this deal. Just remember those key points. If you guys are negotiating a lease and this isn't everything that you should have on there, but these are some of the most important pieces. You want to have an opt out penalty free if your performance is low. One way you could do that is by negotiating occupancy and a nightly rate. Of course, you're going to have to figure out some way to share that information with the owner if they ask for it. You want to have an opt out for short term rental regulations in case they change. You want to make sure that you have the option to put your own locks on there and take care of any repairs that you cover. You also want to make sure that all the utilities, any maintenance, any trash, any common area expenses, those things are all included in your lease. So really think it through. But I'm excited for you guys if you're going this route too. I think it's great just to get in the game to make some really good cash flow and also to preserve some of your capital for investing later if you want to. Good way to make money without having to spend a lot of money up front. I'm excited to keep you guys posted on this. I'll let you know how it goes in future episodes. But until next time, have a wonderful day. Want to get on the fast track to financial freedom through short term rentals? Well, it all starts with the properties you acquire, but you want to make sure that you acquire the right properties. I want to give you my ebook that will show you how to do just that. There is no charge. It's my gift to you for being one of our subscribers. Just go to restmethods.com. that's R E S T methods dot com.
