Introduction
I think we can all agree that a diversified portfolio of investments should hold real estate (“Why You Should Invest in Real Estate”). But within real estate there are multiple sectors and types of securities you can hold. While the traditional way to invest in real estate is through REITs or buying long-term rentals, we believe in the near future owning short-term rentals will present one of the best ways to get exposure to real estate.
The Macro Picture
It’s 2010 and you are buying a property. How do you assess the value of it?
- Look at comparable recent sales
- Determine the property’s potential long-term rental rate and based on the area’s capitalization rate (cap rate) arrive at a price
If you were to do the same exercise today you would have to include a third variable: potential cap rates using short-term rental cash flows. The STR potential cap rate could help explain some of the property appreciation we see in places like Florida. Indeed, it also helps explain why some investors are willing to pay very high prices for some properties.
The value of an asset is the present value of it’s discounted cash flows. Let’s use the cap rate of a property as an example. Remembering that the cap rate = net operating income (NOI) / property price.
As an example, a property is rented to long-term tenants and generates an NOI of $20,000 every year. Our analysis indicates that similar properties sell at a cap rate of 10%, hence the value of the property is $200,000. But what happens when the same property is used as a short-term rental and generates an NOI of $40,000 a year? Selling it at $200,000 would mean that it’s cap rate is 20%. If I’m an investor trying to acquire properties, I would be ok buying the same house for $220,000 or even much more since the numbers would still work.
Think about that last paragraph for a bit. We live in a world where cash flowing assets are scarce, central banks are printing money non-stop, and savers are generating 0% interest rates in their bank accounts. Similarly, I hear stories of institutional investors paying hefty sums for businesses that can generate steady cash flows, and they are now opening up to this asset class. It’s for those reasons I’m so bullish (to use a Wall Street term) on the short-term rental market.
As an investor I believe that the macro factors explain a bulk of the performance of the asset class. For example, if you believe real estate prices will go up on average 20% over the next 5 years, would it matter if you buy one property vs another one in the same community? All else equal, no. Consequently, if my macro thesis on short-term rentals is correct, investors will generate significant profits in this market.
Other Benefits
The following are some additional benefits of owning short-term rentals.
- Own a property in a vacation area (potentially)
- Generate potentially higher cash flows than through long-term rentals
- Property appreciation + equity accrual
Interested in learning more about short-term rentals? Take a look at our “Short-Term Rental Investor’s Guide”
Any questions or looking to buy your first or next short-term rental? Feel free to reach out through our contacts form.
