You're ready to start analyzing properties that you will purchase and rent out under the STR model...so, where to start?
In this article, we will discuss general pre-acquisition due diligence, as well as financial considerations, one should consider before purchasing a property that you plan to STR.
GENERAL DUE DILIGENCE (DD)
Research target markets (local ordinances and zoning): Rules/local ordinances vary dramatically by market. For example, while one market in Florida may allow all the units in an 8-unit multi-family property to be STRed (yes, we just made that a verb….), as of this writing, Chicago limits the number of units in a multi-family property that can be STRed at 25% if the property doesn't have 'hotel' zoning. Given the variability by market, this should be step 1 of your DD.
Focus on markets with high-travel demand or limited extended stay lodging options: Go where the people go, whether it be leisure or business travel. Perhaps a non-obvious trend in STR is that business travelers are increasingly becoming a larger portion of this market. Having a property on the beach in San Diego is certainly a plus, but don't forget about centrally located properties in large metro markets like Chicago or Boston that have significant business travel day in and day out, as business travelers are generally less price-sensitive than vacationers.
Research competition: Once you've identified your target market, research and call your competition. As you look at the comps on sites like AirBnB and Homeaway (just to name two), you will likely start to notice one or more 'hosts' that have multiple listings. Reaching out and talking to these people can yield incredible insights.
Revenue: Estimating revenue starts with researching your competition and establishing your conservative ADR estimate (e.g. price). One you have your price estimate, you next estimate your occupancy percentage (e.g. volume). Paid third party sites such as AirDNA.com provide ADR and occupancy stats by zip code and can be very helpful in making these estimates. Note, however, that AirDNA data is limited to AirBnB data only and does not reflects stats from all STR websites. When estimating revenue, keep seasonality in mind. For example, ADR and occupancy should be much higher for a beach front Florida property in January versus July, all else being equal.
Expenses: Unlike a long-term rental, if all the units in your property are being STRed, it is most likely you will be responsible for 100% of the property's expenses. So, whereas a tenant may pay for gas and electric in a long-term rental, you as the owner will be responsible under the STR model. Furthermore, travelers all require Wi-Fi and bedding/towels, but now also expect hotel type amenities like soaps/shampoos, kitchen cookware, as well as smart TVs with cable and Netflix. Research your competition and include these in your proforma if applicable. Lastly, you should generally expect higher repair and maintenance costs in STR vs long-term renting due to wear and tear from guest turnover.
Capital expenditures (e.g. furnishing): While you must get the P&L right, let's not forget that STR properties need to be fully furnished by the owner. For example, we recently spent approximately $11,000 furnishing a 1,300 square foot 3 bedroom / 2-bathroom condo, and while very tasteful, this was only our costs and did not include a decorator, movers, or high-end furniture. Knowing your market and furnishing appropriately is extremely important to maximizing your revenue.
When doing your due diligence, make sure the numbers work under a long-term rental strategy and not using STR assumptions only. We will not make an investment where the numbers only work under an STR strategy - rather, STR should be upside to your investment thesis. Why? We do this for three key reasons:
It is still the 'early days' for STR and regulations are constantly changing. If your local market outlaws STRs or changes the rules, you want to make sure you can still earn a reasonable rate of return on a long-term basis.
If/when the economy contracts and tourism declines, we want to be able to quickly pivot to LT rentals. Other than the money spent on furnishing (which you still may be able to use), the switching costs are more or less nil.
Like most things in life, real estate investing involves risk. However, we are always looking for ways to 'manage and reduce risk'. The above actions are just a few ways we manage risk in our STR investing busines.
Did we miss anything? Let us know in the comments below!
As always, happy STRing!