Today’s topic is something I discuss with our community on a weekly basis: What kind of rental should you invest in? What makes sense? What’s better for your investment profile? What are the pros and cons?
For those new to the world of real estate investing, it’s important to recognize that there are two major categories of rental investment types: short-term and long-term rentals. And for anyone wondering about the differences between two, you’re not alone.
When I first started investing in real estate, I realized that there were a lot of key concepts to get my head around. Ultimately, doing so would best position me for investment choices that would help me achieve my financial goals. That is absolutely true with investing in rental properties.
Today, we’ll go over both types of rental investments, including how they function as investments and the potential pros and cons of choosing them as part of your investment portfolio. We’ll cover their expected returns, management fees, risk profiles, tax implications, and time commitments.
So sit back and get ready to continue your investment education—you are taking a step closer to achieving enduring wealth and living the life of your dreams. On that journey, make sure to stay engaged with your communities and work with your financial team to best align your choices with your overall financial goals.
What Are Short-Term and Long-Term Rentals?
First: the basics. Short-term rentals are defined as an investment property where the tenant stays for one-to-thirty days, such as vacation rentals or Airbnbs. For example, a beachfront condo rented out during the summer. Renters appreciate the flexibility short-term rentals offer compared to hotels. These properties are easily accessible through technology like Airbnb, VRBO, and HomeAway, benefiting both vacationers and property owners.
On the other hand, long-term rentals span periods of one year or more, catering to stable tenants seeking extended housing. An example would be renting an apartment for several years while going to college.
There is a middle ground between these two types, called mid-term rentals. I’ll cover those in more detail in a future blog, but their tenant stays range from one-to-twelve months. These offer a balance of flexibility and stability for both landlords and tenants.
How Short-Term and Long-Term Compare
Let’s look at some major considerations when comparing both asset classes for your own investment portfolio. Keep in mind, though, that this is not an exhaustive list, and it’s important to do your complete due diligence when evaluating which might be best for you.
Returns and Vacancy Rates
These two concepts go hand-in-hand because one directly affects the other. Short-term rentals are expected to yield higher returns. This is because the price for shortened stays is more equivalent to staying in a hotel. Short-term rentals are in the hospitality game, after all. It depends on the property, but short-term rentals experience higher vacancy rates, sometimes taking a sobering bite out of the alluring high returns that they offer.
Long-term rentals provide a steady, predictable income. This income will be at comparatively lower rates because their pricing is determined by the housing market. Additionally, with lease agreements and the constant need for housing, vacancy rates are much lower.
Property Management Fees
While it surprises some, short-term rentals incur higher property management fees due to frequent turnovers and guest services. It’s not unusual for the owner of a short-term rental to live out of state, requiring that a manager be hired to look after the property. Expect fees to be around 20-30% of your gross income.
Long-term rentals, on the other hand, generally have lower management fees because, except for the occasional need to fix something, they require less oversight. The bulk of the work will be devoted to tenant retention. The fees for long-term rentals are usually between 5-10% of gross income.
Risk Management
Laws for short-term rentals can change more frequently, creating a bigger risk profile than its long-term counterpart. One extreme but not unheard of example is a ban on short-term rentals in the investment property’s area. There’s also seasonal demand. For example, if the property is near a ski resort it may not generate much income in the summer. Are you willing to take the risk of demand fluctuations?
For long-term rentals, the major risks involved are tenant defaults. When tenants break their lease, the property’s predictable income will be in disarray until you can find a new tenant. There are also risks on rental pricing. Market shifts in demand can impact how much you can charge for rent. Regulatory risks to consider include eviction moratoriums and rent caps.
Tax Impact & Management
What about your taxes? Short-term rentals are businesses, so you can take deductions for expenses like cleaning and maintenance. That can lower your tax burden substantially, as rental income is usually taxed just like ordinary income. You have options, though, on how to plan your taxes for the most efficient savings. For example, you can qualify for a short-term rental loophole, allowing you to offset active income with rental losses. You must qualify as a real estate professional in order to take advantage, though.
With long-term rentals, rental income is taxed differently. However, that tax burden can be lessened by depreciation deductions and long-term capital gains tax rates. These benefits will be affected by how long you plan to hang onto the long-term rental as an investment. For either asset class, make sure to work with your CPA to keep more money in your wallet.
Time Commitment
If you’re like me, you like creating passive income streams to build enduring wealth and live a dream life. For some, that dream life could include a side hustle, such as working in property management. For others, they don’t want to put in the extra work. So let’s look at the time commitment for both forms of rental investments.
In the short-term rental industry, there are more frequent management tasks, such as guest communication, cleaning turnovers, regular maintenance, and marketing. Whether you want to spend your time doing that is up to you. But if you’re looking for more passive income, consider hiring a property manager to run your short-term rentals.
Long-term rentals require less immediate attention and, overall, have a smaller time commitment. Your time will be spent building professional relationships with your tenants. You’ll also be required to occasionally repair some part of the property, whether taking the time to do the labor yourself or vetting the right contractor.
Which Rental Type Is Right for You?
Due diligence through education and understanding individual investment goals is vital in determining which type of investment you want to consider. What are your goals, risk tolerance, and willingness to manage a property? Those are factors, but so are so many other things.
Are you hungry for more? Wherever you are in your real estate investment journey of learning, you can benefit from our Passive Real Estate Academy! It’s a four-week course that gives you all of the foundational knowledge about how to make passive income from real estate investing. You’ll also tackle current real estate market conditions and work with a group of like-minded investors to network and make connections.
Click here to sign up for our Fall Cohort by getting on the waitlist. We hope to see you in the Fall! And regardless of when we see you next, we here at Passive Income MD hope that you take the actionable steps necessary to make your financial goals a reality.
Peter Kim, MD is the founder of Passive Income MD, the creator of Passive Real Estate Academy, and offers weekly education through his Monday podcast, the Passive Income MD Podcast. Join our community at the Passive Income Doc Facebook Group.
