The proliferation of short-term rentals, courtesy of platforms like Airbnb, has been making headlines for the last few years. Renting apartments on a short-term basis is certainly not a new concept; some investors have utilized this approach for decades. However, the advent of online sites like Airbnb have made it easier for the masses to rent their apartments on a short-term basis, even for as brief as a one-night stay.
There’s been great controversy over short-term rentals. The biggest opposition has come from the hotel industry, which rightfully argues that these rentals are effectively functioning as hospitality properties without being subject to the same rigorous regulations or tax structure. Community residents have also expressed concern over the impacts short-term rentals have on their local neighborhoods, which we’ll get into more detail below.
Nevertheless, buying properties with the intention of renting on a short-term basis is an investment strategy that continues to grow in popularity. Many investors have found they can maximize revenue by renting on a per-night basis as opposed to on more traditional, year-long leases. This approach is having a major impact on demand for multifamily housing, and related, on overall housing affordability.
Increasingly, municipalities are responding by adopting stringent restrictions on short-term rentals. Cities in California and Oregon are among the forefront of these new regulations. Any investor who is considering this approach, particularly in one of these west coast states, should first spend some time investigating the potential consequences on doing so.
In this article, our experts at Trion Properties look at some of the pros and cons of investing in short-term rentals, as well as some of the impacts this approach has on housing affordability.
What Is a Short-Term Rental?
Short-term rentals can take many forms. The term is used generically to describe any residential property that is leased temporarily. The duration of a short-term rental stay can vary. Historically, short-term rentals were leased on a weekly or monthly basis. Increasingly, properties are now being rented on for as little as one night. In either case, the term short-term rental is used to differentiate the rental from a traditionally-leased property, that latter of which tends to take place using a year-long contract that converts to month-to-month at the end of the first term.
A key feature of short-term rental properties is that they typically come fully-furnished. Renters simply need to show up with their suitcase. All appliances, furniture, and other major home supplies are already provided. This also stands in contrast to most long-term rentals, which are typically leased unfurnished.
Short-term rentals have historically been viewed as an alternative to staying in a traditional hospitality property, such as a licensed bed and breakfast or a hotel. It’s no wonder, then, that the hotel industry has come out against the proliferation of short-term rental platforms. Indeed, this new breed of rentals, described in more detail below, is a direct threat to traditional hospitality.
Types of Short-Term Rentals
There are two primary types of short-term rentals: short-term leases and short-term rentals made available through Airbnb and other home sharing services.
As noted above, historically, short-term rentals were properties leased on a weekly or monthly basis. They were often utilized by business people who had to travel frequently for work, or who were on long-term assignments in communities far from their home. Many professional athletes, for example, will sign short-term leases when being signed to a new team, depending on the length of their contract and possibility of being traded in the near future. These “corporate” rentals are usually more affordable, on a nightly basis, than staying in a traditional hotel for several days.
Short-term rentals are also commonly used by people who are relocating to a new city, or for another reason, are temporarily out of housing. For example, a couple undergoing a major home renovation may need a short-term rental for three months while the work is underway. Similarly, a family may be relocating from one coast to another for the sake of a job opportunity and may need an apartment on a short-term basis until they can sell their current home and buy one in their new location.
Airbnb and Home Sharing Services
The short-term rental market has evolved rapidly in recent years, primarily due to the growing popularity of home-sharing sites like Airbnb, HomeAway and VRBO. These platforms make it easy for anyone to list their home, apartment or other property for rent for as little as a one-night stay. Some renters will utilize these platforms to find more traditional short-term rentals, as they would have previously when needing short-term corporate housing, but many more people now use these platforms for brief stays in lieu of staying at a hotel or other traditional hospitality property.
Home sharing services like Airbnb draw a diverse demographic traveling for a range of purposes. Short-term rentals are increasingly utilized by business travelers, vacationers, and those just passing through an area who need a place to rest their heads. These platforms allow people to rent an individual room in someone’s home or an entire apartment, depending on your needs. Many will find that renting through a home sharing site is much more affordable, particularly if needing multiple rooms, than booking separate rooms at a corporate hotel.
What Are the Effects?
The rapid influx of short-term rentals, courtesy of Airbnb and its peers, has had several effects on the housing market.
Let’s use the following example.
An investor can rent a 3-bedroom apartment in Nashville for $1,750 per month. That same investor realizes that he can rent the apartment on a short-term basis for as much as $275 per night, particularly if adding amenities that would be conducive to tourists traveling to Nashville for the weekend (Nashville is a city that has become popular among bachelor and bachelorette parties). The investor only needs to rent the apartment for ten nights per month to earn $2,750 per month, a thousand-dollar profit over what they would earn from a traditional, long-term lease. A portion of that revenue will go toward Airbnb’s fees, but nevertheless, it’s a more attractive investment prospect than leasing long-term.
Let’s look at the impact this investment strategy has had on several factors, like rental prices and vacancies.
Any property that is converted to use as a short-term rental results in one less long-term rental available in the marketplace. Fewer long-term rentals, absent less demand or increased housing construction, means decreased supply for the long-term rentals that remains. In many communities, this has caused a dramatic uptick in rental prices. Some investors have noted the increased rents for traditional, multifamily housing in these areas, but the construction process is typically slow to catch up with rising demand.
The proliferation of short-term rentals has had a dual-impact on vacancies. On one hand, vacancies for long-term rentals has plummeted as fewer units are available. On the other hand, apartments rented on a short-term basis tend to sit vacant more often, on a nightly basis, than those that would otherwise be rented to full-time renters. In other words, these short-term rental apartments “go dark” for more nights per month than they would otherwise – a frustrating prospect for renters shut out of the marketplace.
Impact on Renters
Short-term rentals have had a significant impact on existing and would-be renters alike. Let’s say that 3-bedroom apartment in Nashville is one of two units in a duplex. When the investor decided to utilize this apartment as a short-term rental, he took one more housing unit off the market for the broader, long-term renting demographic. With fewer units available, those that remain for long-term rental become more competitive and therefore, more costly. Several renters are feeling the pinch as a result.
There are other impacts on renters to consider. Let’s consider the renters who live in the duplex’s other unit. They’re long-term renters who have signed a year-long lease. When they selected this apartment, they expected reasonable peace and quiet as this is an otherwise calm residential area. But now, these renters are contending with a revolving door of short-term guests staying in the apartment next door. The occassional rowdy group playing loud music routinely disrupts the renters, causing such discontentment that the long-term renters are now looking for ways to break their lease agreement so they can relocate elsewhere.
Housing Affordability Compared
There is a growing body of evidence to suggest that short-term rentals have a significant impact on housing affordability. This is true for all stakeholders: homeowners, renters and investors alike.
How Short-Term Rentals Impact Affordability
Investors who realize they can generate higher profits by renting on a short-term basis are increasingly willing to pay a premium for properties that otherwise wouldn’t pencil out when leasing traditionally. This has caused housing prices to spike in some areas, shutting out the average homebuyer.
Let’s look at how short-term rentals impact affordability for each of the three aforementioned demographics: homeowners, renters and investors.
Airbnb and its competitors all pitch its benefits to homeowners. While yes, home prices in areas with many short-term rentals may be on the rise, homeowners can easily generate income to offset those costs by occasionally renting their home. For example, a homeowner may be willing to bid $75,000 over the listing price for a home they think they can rent out on occasion. This additional $75,000, when amortized over 30 years at a 4.5% interest rate, adds about $380 to the monthly mortgage.
A homebuyer who thinks they can rent their apartment just one weekend per month for the equivalent of $380 might be willing to pay a premium for this property. So yes, Airbnb can make homeownership “more affordable,” but it is also driving up home prices for the masses. What’s more, not everyone can (or will want to) rent out their home on occasion. This is a risky prospect for some who must rely on that income.
Renters bear the brunt of Airbnb’s impacts, as traditional rentals are converted to short-term rentals, thereby removing long-term rentals from the marketplace. This drives up the price of the long-term rentals that remain. In theory, renters could also offset these higher costs by occasionally listing a room in their apartment on Airbnb, but leases increasingly prohibit renters from doing so.
In many markets, investors have realized they can generate higher profits by renting on a short-term basis than they could leasing the same unit on a year-long lease. This has become a common investment strategy in some markets, such as Los Angeles, which appeal to both those traveling for business and those traveling for leisure alike. As expected, the potential profitability of short-term rentals in these markets has driven home prices even higher, which investors then offset through more management-intensive but higher revenue-generating short-term leases.
Conversely, the growing shortage of traditional apartments in these markets has created an opportunity for investors willing to buy or develop multifamily housing. Value-add apartment investors, in particular, have been capitalizing on increasingly tight rental markets by luring those forced out of apartments that have since been converted to short-term rentals.
Legislation for Short Term Rentals
The impacts of short-term rentals on the broader housing market has not been lost on municipalities. Several jurisdictions, particularly on the west coast where short-term rentals have exacerbated local affordability crises, have pursued legislation that would restrict who can lease properties on a short-term basis, for how long, and under what circumstances. Many have adopted regulations that tax short-term rentals at the same rate hotels are taxed, and now require hosts to register and file as though they were a traditionally-licensed business.
Here are a few examples of short-term legislation that has recently passed.
- In December 2018, Los Angeles adopted sweeping legislation that restricts how long people can rent out their homes using sites like Airbnb. Hosts can no longer rent their unit for more than 120 days per year. The regulations also require hosts to register with the city, paying an $89 application or annual renewal fee, and requires the rental to be the host’s primary residence.
These regulations have effectively banned corporations seeking to list apartments on a short-term basis, which has had a crippling effect on investors who previously purchased properties with the intent of deploying a short-term rental strategy. Anyone who violates the new regulations can be fined up to $2,000 per day. The new law took effect in July 2019.
- Pacific Grove, California has implemented a lottery system that allows for 51 homeowners to obtain short-term rental licenses each year. This strategy is intended to cap the number of short-term rentals at any given time. Pacific Grove also requires hosts to collect a 12% “transient occupancy tax” that must be submitted to the municipality on a monthly basis.
- Portland, Oregon now only allows short-term rental of accessory apartments. In other words, whole home rentals are not permitted at all. Only partial home rentals of a primary residence, and lasting fewer than 30 days, are allowed. An owner must apply for a business permit and collect a Transient Lodging Tax to be paid to the state. Portland’s regulations also require homeowners to notify their neighborhood association in advance of leasing their home on a short-term basis.
- Eugene, Oregon allows short-term rentals, under certain circumstances, but has a few unique provisions to which owners must adhere. For example, in addition to collecting the state’s Transient Lodging Tax, homeowners must register with the city directly and remit a 4.5% transient room tax to the municipality. The city has also implemented occupancy limits. Only five un-related guests are permitted at any property at any given time. For example, if a family of three wants to rent a bedroom in their home on a short-term basis, they can only rent it to two unrelated guests at one time.
So far, Massachusetts is the only state to adopt any state-wide Airbnb regulations. In Massachusetts, all hosts must register and pay taxes to the state. Many individual municipalities have then adopted even more stringent regulations that apply within their borders.
The legislation enacted to date has been a direct response to residents’ concerns over housing affordability and the impact short-term rentals are having on their communities. As you can see, regulations can vary drastically from one location to the next. Anyone who is considering investing in a property to use as a short-term rental will want to carefully investigate this patchwork of regulations – particularly as it relates to the area in which you’re thinking of investing.
Moreover, it’s important not only to look at the legislation that has been passed, but also any short-term rental legislation on the horizon. Many proposals are still being floated by cities and towns, and if approved, could have a major impact on an investor’s ability to deploy this strategy. Most investors will want to ensure a deal pencils out as both a short-term and a long-term rental as a way of hedging against this growing uncertainty.
Investors of all kinds should continue to monitor the impact short-term rentals are having on the broader housing market. As we’ve seen, the proliferation of short-term rentals has simultaneously created demand for traditional multifamily housing. In these markets, investors may be best served by going back to the basics and focusing on traditional value-add multifamily opportunities to cater to those displaced by short-term rental investors.