July 7, 2023
Investing in vacation rentals has gained momentum in recent years. Even in this time of economic uncertainty, domestic leisure travel is expected to remain strong, with a normalized growth rate of 2% projected for 2023 and 2024 (according to the U.S. Travel Association®). That means the market is ripe for your vacation rental investment—a potentially lucrative passive income stream.
But, like any strategic financial decision, you’ll need to do your homework first. This article will help prepare you for your vacation rental investment.
Questions to ask before investing in vacation rentals
1. How do I find the right property? Should I hire a real estate agent?
Gone are the days of having to search for “For Sale” signs in your local neighborhood. Today, real estate investors have fast access to information via online listings.
Furthermore, the purchasing process has been streamlined with modern conveniences, which can include everything from online prequalification for financing to digital closing procedures.
In any case, you may feel more comfortable partnering with a real estate agent to make sure you secure a property in line with your goals. Just keep in mind—if you do hire a real estate agent, they should specialize in vacation rental investment properties and be able to help guide your search.
2. Is there construction nearby?
In the short term, construction may mean increased noise levels and unsightly equipment. In the long term, it could mean more amenities and other structures that boost the value of your investment.
Generally, the more construction you see, the more reliable the indication of growth.
At the same time, it’s important to look out for developments that will likely compete with your vacation rental, as well as those that could impact its price.
3. How much should I set aside to cover maintenance expenses?
Maintenance costs add up fast. As a general rule, it’s recommended to allocate 1% of the total value of the property per year for maintenance.
For example, if your vacation rental property is valued at $400K, you would need to budget $4K each year to cover maintenance expenses.
4. Should I hire a licensed property management company?
Before deciding, it’s important to understand the role of a property manager and what they should be expected to bring to your relationship. Typically, a property manager’s responsibilities include the following.
A reliable property manager is an important asset to any real estate investor. However, this support comes at a cost, as property managers generally charge between 8% and 12% of the monthly rent—substantially impacting your cash flow.
One consideration to keep in mind is whether it would be more expensive to maintain the property yourself or to have a property manager do it. Remember that cost can also be measured by your time, not just the dollars you spend.
Quick tip: If you enjoy getting very involved in your projects and consider yourself “hands-on,” a property manager may not be a good solution, as you’ll have to split decision-making power with another individual.
5. Is the investment property in a good location?
Location is critical for all real estate purchases, but especially vacation rentals.
As vacationers are looking to experience the best of the best in the area, you’ll want to make sure your property is right in the middle of the action. It should be close to popular attractions, restaurants, shops, and public transportation.
However, these are not the only factors to consider. If you plan to use the rental yourself, ease of access will likely become an important factor, requiring you to narrow down your list to properties that are within driving distance.
Be sure to consider all these factors as you’re searching for and evaluating your options.
6. Will the cash flow from this property meet my needs?
You’ll want to narrow down your list to properties that offer the opportunity for capital appreciation and are simple to manage. But for most investors, profitability takes priority—a projection of positive cash flow on an annual basis is key.
Perform your due diligence and ask yourself these additional questions to determine whether the potential investment will meet your financial requirements:
You may consider a minimum return on investment (ROI) when making a purchase. This can be determined by dividing expected net cash flow by the cost of the property. The typical target for investors is between 6% and 12%.