Vacation rental owners should look to make no less than a 10% return on their investment.
That means your income minus expenses (net operating costs including any mortgage payment) should be no less than 10% of your initial investment per year. This is expressed at the Capitalization (or Cap) Rate. So, for example, if your property costs $100,000 and you make $10,000 per year after all expenses, you will have a 10% Cap Rate. However, vacation rental property profit margins are dependent on many different factors. Although they are generally far more profitable than long-term rentals, their profit margins fluctuate more. Let’s dig deeper.
Location is everything
OK, maybe the location isn’t exactly everything, but it comes close. Guests of vacation rentals may be willing to overlook some cosmetic deficiencies if a beach house is actually on the beach. Here are some essential factors to consider when gauging a property’s location.
It is close to essential amenities: Advertising a vacation rental as a beach house, lake house, farmhouse, or Disney Land rental means being on the very doorstep of those amenities. In the case of the waterfront properties, a shoeless walk, preferably on sand or grass, to the water should not be out of the question.
Is it accessible: Driving to the property should not take safari-like measures.
It has nearby local amenities: Yes, you’re on vacation but stocking up on essentials like groceries, toiletries, local tours, stores, etc., should not take you across different zip codes.
It looks good: Looks aren’t everything, but they count for a lot when it comes to a vacation rental. So not only do you want your rental to look good online and in marketing photos, but you want to give your guests that “wow” factor the moment they lay eyes on it. This means curb appeal, including landscaping and exterior finishes, matters greatly.
Safety: This goes without saying, but car alarms, gunshots, or nefarious-looking characters congregating near the premises will not win you any positive ratings. They will keep your place vacant. Make sure your vacation rental is secure and safe in a well-regarded neighborhood.
Limited competition: Competition often raises standards, but for a vacation rental business, it can affect profits too. There’s no harm in being a big fish in a small pond and having limited competition.
Steer clear of renovation nightmares
Dilapidated buildings in serious disrepair might be cheap to buy, but they can cost a fortune to renovate. Steer clear of severe renovation projects on your first vacation property that can spiral out of control, taking you decades to recoup in rental income. Cosmetic upgrades are OK, but anything structural is a no-no. The same goes for any historically landmarked buildings that can take you through a red tape and restrictions labyrinth.
Your mortgage rental matters
Many loan products are available, and you want to get the cheapest one possible. For example, suppose the home needs some cosmetic work. In that case, that might mean living in the house while renovating, allowing you to benefit from a low downpayment FHA loan. After a year, you can move out and turn the home into a vacation rental but still keep the low-interest rate. This means your ROI will be much higher than if you put down 20-30% of an investment property loan or borrowed hard money before refinancing into a conventional loan.
Invest in a good insurance plan
You might not think this can affect your profitability. However, if you are inadequately insured, and something goes wrong, you’ll wish you’d spent money on ironclad protection. Many vacation rentals are in remote locations and are susceptible to natural disasters like storms and flooding. Look to see what’s covered and if you can’t find a plan that lets you sleep well at night, make sure you have a healthy cash reserve built up to protect you from anything unforeseen.
Plan for the slow months
If you own a beach house, the winter months might prove challenging—however, many people like the idea of cozy cabins on wintery windswept beaches. Be creative in your marketing and let potential guests see the value in your home, even in the off-season. Alternatively, invest in a year-round tourist destination like Miami and enjoy predictable annual revenue.
Understand local laws for vacation rentals
Global destinations such as New York City and San Francisco have very restrictive laws concerning vacation rentals. Ensure you understand all the local regulations regarding damage deposits and minimum or maximum stay requirements for your town or city.
Get a quality management company
If you want to work on your business and not in it, hire an experienced management team to take care of bookings, repairs, and cleanings. Paying their fee will allow you to scale your business and generate greater profits. Read reviews and interview several companies before deciding on one.
Summary
There’s no reason you won’t be able to enjoy massive profits with your vacation rental business, but you’ll need to do your homework first. Choosing the right location is an essential first step. Once you have done that, there are many other things to consider. Go through them carefully, and when you’ve done that, number crunch estimates conservatively to predict your profitability. Once you know your parameters, start house hunting. Vacation rentals are providing record profits for investors. So there’s no reason you can’t be one of them!
