Introducing Short-Term Rentals
Short-term rentals are one of the fastest-growing commercial real estate sectors, valued at $1.8 trillion. As investors look for more stable and secure assets after the global pandemic, short-term rentals offer significant upsides. This is particularly true in high-demand tourism markets like Southern California and other coastal regions. Now, some of the biggest names in commercial real estate are chasing alternative assets to increase cash flow and diversify their portfolio, turning short-term rentals into long-term investments.
What Is a Short-Term Rental?
A short-term rental (STR) is a furnished property that is available for patrons to rent for a limited amount of time, oftentimes used as vacation rentals. The niche asset class rose in popularity with the inception of Airbnb, a worldwide STR facilitator that reported $1.5B in revenue in Q4 2021. Airbnb catapulted short-term rentals into the real estate spotlight, offering high daily rents and low operating fees. The sector grew wildly popular after the onset of COVID-19, as employees started working remotely and travelers began visiting destinations for longer periods.
“Between 2018 and 2021, demand for Airbnb and Vrbo-style rentals in destination and resort locations rose by 25%.” – MorningBrew
As local and private investors entered the market to take advantage of home-sharing services, institutional investors took notice of the perks. Short-term rentals can be scaled and expanded to create diverse portfolios with higher-than-average yields. Depending on the market, a STR property can generate up to 3x the amount of monthly rent. The asset class allows for turnkey property management, producing a higher profit margin and incentivizing investors to buy large STR portfolios over a single multifamily building.
The market is facing its fair share of challenges. Regulations regarding the sector are slow due to its infancy. Many local governments are feeling the pressure from citizens to limit the number of STRs a city or neighborhood can have, as citizens hope to keep their neighborhoods free of never-ending droves of tourists. Many politicians and activists are also pointing out that STRs are contributing to the housing shortage, as home buyers are being priced out of the market due to out-of-state investors buying up inventory to rent out. In turn, increased housing prices are hindering cities’ goals to improve their affordable housing supply, pitting operators, city, and community leaders against each other.
Despite these challenges, the short-term rental sector is here to stay. While regulations may sound worrisome, they are also indicative of a maturing market. STRs provide significant benefits to local economies, as cities reap additional tax revenue, and local businesses and restaurants benefit from increased tourist spending. Therefore, it is vital cities incorporate a balanced approach to address community concerns while adapting to meet the shifting accommodation demands of its visitors.
“The long-term rental market may offer reliable profits, but short-term rentals can potentially yield 70% more revenue per property.” – MorningBrew.com
Property prices for long-term rentals are experiencing high inflation due to low-interest rates, which has crowded the purchasing and borrowing space for multifamily investors. Despite the recent rise in rates, this challenge has caused cap rates to compress, specifically in high-demand regions like Southern California. Short-term rentals are a viable solution for formulating a strong multifamily deal in a compressed cap rate environment, as they offer increased yields. Newport Beach, a high-priced coastal market and popular tourist destination attracting over seven million people annually, is a great example of this benefit. The average market rent for a one-bedroom apartment in Newport Beach is $3,000 per month, but a short-term rental market average daily rate is $275 per night at 80 percent occupancy, totaling $6,600 per month. Considering typical cap rates in this high-price market hover below 3 percent for traditional multifamily, positioning an asset as a short-term rental can in many circumstances double an owner’s return and make deals pencil that otherwise would not.
“The U.S. short-term rental market reached its highest growth rate since the onset of the pandemic. Property owners are cashing in on high demand levels by increasing their average daily rates, which reached $243.28 in October 2021, an increase of approximately 25% compared to two years prior.” -GlobeSt.
Private and Institutional Investment
Institutional investing is still new to the short-term rental space, but as institutions look to diversify their portfolios with pandemic-resistant assets in business-friendly states, short-term rentals will continue to grow in popularity. Several prominent players have partnered with rental property management companies or short-term rental developers to enter the expanding market. As inflation continues to rise, short-term rentals are expected to thrive as more consumers are priced out of the home buying process and look to STRs as the solution. Private equity firms and institutional investors have shown their interest in the sector over the last few quarters by investing in stocks of rental property companies. Skift reported Level Equity and TPG Capital have notable holdings in Vacasa, a branded vacation rental property manager.
Will Short-Term Rentals Replace Multifamily?
The elevated interest in short-term rentals has yet to replace traditional multifamily investing. Short-term rentals provide renters with more flexibility since the leases are much shorter than the typical 12-to-18-month lease periods apartments provide. The benefit of shorter leases for landlords is that they can capitalize on increased market rent and adjust their pricing more frequently. The downside for landlords is the risk of high turnover and vacancy. Long-term multifamily investments provide a stable, profitable income and are often financed much easier than short-term rentals. The STR market is fresh and will take time to provide the reliability and security traditional multifamily offers. Large institutional and private investors aren’t pulling capital from multifamily investing, they are adding STR to an already established portfolio.
Overall, short-term rentals offer opportunity, profitability, and security for investors. The unique asset class offers higher cash flow at relatively affordable pricing in growing markets throughout the U.S. Although new to the sector, institutional investors are predicted to increase their funding and activity in the short-term rental environment, cultivating new developments and capital.
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