As a short-term rental investor, I’ve been asking if it’s still profitable to invest in short-term rentals (STR) with rising interest rates?
There is a lot of uncertainty in the market right now, and many are asking if certain real estate assets are still profitable with rising interest rates. We’re all quick to jump to the Great Recession and compare it to what we’re currently or soon could be facing.
Though it is important to study market cycles to figure out if we could be moving into a recession, I would caution you to understand that every market cycle is unique. Many of the attributes that caused the last recession probably won’t cause the next recession.
According to AirDNA’s 2022 Vacation Rental Outlook Report, “The pandemic has accelerated STRs into the mainstream. Demand is already 10% higher than during the pandemic, the industry is generating 40% more revenue, all with 10% fewer listings. As more investors add supply to capture the growing demand of the industry, it will evolve and adapt to changing consumer trends. Expect to see more unique properties in off-the-beaten-path locations providing one-of-a-kind experiences that will accommodate guests seeking an alternative to traditional lodging options.”
According to the graph, the average revenue for short-term rentals is climbing higher and higher. While the projection shows revenue evening out and moving into a slight decline, it’s still higher than in years past.
Another interesting statistic that the report highlights is the rise of remote work during the pandemic. 60% of workers returning to the office are expected to choose a hybrid approach for returning to the office. Most of the guests who book my properties on the weekdays work remotely during the day and explore the city at night.
In essence, a lack of STR supply and the rising popularity of remote work will be the driving factors in the continued demand for short-term rentals throughout the rest of 2022 and into 2023.
If anything, the competition will become fiercer, and property owners will be looking to differentiate themselves from the crowd. The most significant trend I see is developers building unique properties such as log cabins, A-Frames, treehouses, and tiny houses to differentiate themselves from “normal-looking” properties on the market.
Case Study: What Doubling Your Interest Rate Could Do To Your Cash Flow
The first short-term rental I ever invested in was a 900-square-foot A-Frame that I did a ground-up construction on. After renting it out for nearly three years, plus appreciation, I had built a good amount of equity.
This led me to a cash-out refinance to pull some of the equity out as working capital in some of the future short-term rental development deals I had going on with my partners.
I knew that the new interest rate would not be as good as the current rate I had because I was transferring from a residential loan to a more commercial-like loan.
After shopping for lenders, I chose one that specialized in short-term rental loans, and we started the process of getting an appraisal on the property.
The current rate I was operating with stood at 3.25%. After working through the details, my 30-year rate became 4.25%. Unfortunately, it was variable too.
However, the property was grossing about $82,000 per year and netting over $50,000, so I was not worried about the extra percent on the interest rate. I was slightly concerned about the variable part, but the refinance proceeded.
Fast forward a couple of weeks, and we had completed the appraisal and scheduled a closing date. It seemed as if everything was good to go until two days before closing, when I received the closing disclosure stating that the interest rate was hiked to 6.9%.
I called the lender wondering what happened to the 4.25%. It turned out that there had been three interest rate increases over the 45 days leading up to closing. I was speechless.
Going from a 3.25% to a 4.25% interest rate was fine. But to go from 3.25% to 6.9% seemed like a major problem. I was ready to step away from the deal because I could not fathom more than doubling my interest rate.
Before scrapping, though, I was curious to see if the property would still cash flow at 6.9% interest. I ran the numbers based on the 3.25% rate, the 4.25% rate, and the new 6.9% rate, and even plugged in an 8% interest rate.
To my surprise, the property at the 6.9% and 8% rates still had significant cash flow. The loan amount increased from $178,000 to $225,000. The difference in the mortgage payment between the original rate I was quoted (4.25%) and the new rate of 6.9% was only $375 extra.
I was already charging $270 as the daily rate for that rental. I could make up the difference with just two extra bookings. Given that occupancy over the past three years hovered around 95% on average, I felt comfortable going through with closing.
The best part of this case study is that I learned a valuable lesson.
As we dip into a period with rising interest rates (albeit still low historically), short-term rentals will be one of the most resilient real estate investments to rate hikes, making this one of the best times to invest in them.
Do not let the sticker shock of higher interest rates discourage you from moving forward with a deal. Don’t sit on the sidelines and wait for interest rates to drop back to where they were over the past two years. If you do that, you’ll probably never invest in real estate. It took a unique set of circumstances for interest rates to become the lowest they had ever been in history. But as inflation grows and takes a tough toll on the economy, you’ll find that those same easy money policies are well behind us.
Interest rates are increasing. Don’t let that be why you aren’t going out and looking for good deals, even if they double. With a well-placed STR, you’ll find it easy to make up the difference.