Real estate is a great investment vehicle to build wealth and attain ultimate financial freedom. And, one of the best ways to get started is by investing in vacation rental properties. But there are lots of moving parts. You need to educate yourself on how to buy a rental property.
However, if you are thinking about owning these types of properties, you should know a few things before taking the plunge. In this article, we will cover everything you need, so that you know how to buy a rental property. From the basic requirements to management, and everything in between. After all, not everyone who buys a property will plan to live in it.
So, if you want to be successful in this form of investment, read on!
How to Buy a Rental Property
As a new investor in real estate, you might be asking yourself if a vacation rental is a good investment to make. Whether you are just starting out in the real estate business or are someone who wants to diversify your portfolio, the answer is definitely “yes!”
For one, renting out holiday homes has proven to be a very lucrative business. In fact, according to a vacation rental forecast by Lodgify, the average daily rate for these types of properties was expected to increase by 23% in the second quarter of 2022.
What’s more, with the rise of Airbnb and other home-sharing platforms, it has become easier than ever for holiday-makers to find and book vacation rentals. This means that there is a growing demand for these properties, which is good news for investors like you.
And of course, let’s not forget about the tax benefits that come with owning a vacation rental. You can deduct the mortgage interest, property taxes, and other expenses from your taxable income. This can significantly lower your tax bill at the end of the year.
Apart from making income, owning a vacation rental property will give you the opportunity to meet new and interesting people from all over the world. You will also get to experience different cultures and learn about new places.
So, is a vacation rental a good investment? We say, “absolutely!”
Vacation Home Investment: 3 Basic Requirements
Like other types of property investments, there are certain requirements that you need to meet before buying vacation rental properties.
You need to have enough capital for the down payment and other associated costs in buying these properties. For instance, in the US and Canada, the average down payment for a second home (the category where vacation rentals belong) is around 20% of the purchase price. So, if you’re looking at a $500,000 property, that’s $100,000 that you need to have upfront.
You will also need to factor in the closing costs, which are typically around 2% to 5% of the purchase price. These include things like loan origination fees, appraisal fees, and title insurance.
How to Raise Capital for Your Vacation Rental
To get adequate financing for your investment, you can take out a mortgage loan. Just make sure to shop around for the best rates and terms.
Also, fix your credit score before applying for a loan to get a high chance of getting approved. This is because most lenders will require a minimum credit score of 680 or higher for loan approval.
Your debt-to-income (DTI) ratio is also an important factor that lenders will consider. This refers to the percentage of your monthly income that goes towards paying debts, including your mortgage payment, car loans, and credit card bills. Ideally, your DTI ratio should not exceed 28%. This means that if your monthly income is $5,000, then your maximum monthly debt payments should not be more than $1,400.
Another option to raise capital is to partner with other investors who can help you with financing your purchase. This way, you can buy a bigger and more expensive property that has the potential to generate higher rental income.
You can also consider getting a home equity loan if you already own a property. This approach allows you to borrow money against the equity of your home. Just make sure to carefully weigh the risks and benefits before taking out this kind of loan.
For useful information about financing a vacation rental property purchase, you can check out Rental Property Investment.
2. Business Plan
Before you buy a vacation rental property, you first need to have a clear business plan in place. This will help you determine the type of property that you want to buy, as well as the location and price range.
Your business plan should also include your target market, rental rates, and estimated expenses. This will give you a better idea of whether or not buying a vacation rental is a good investment for you.
To come up with an effective business plan, answer the following questions.
- Who is your target market?
- What type of property do they want?
- Where are they willing to stay?
- How much are they willing to pay?
- When do they need the rental?
- What are your estimated operating expenses?
Another important component of your business plan is an exit strategy. This refers to the plan for when you no longer want to own the property. Some common exit strategies for vacation rental properties include selling the property, refinancing, and renting it out for the long term.
3. Marketing Strategy
Make no mistake—it will be difficult to generate a healthy return on investment (ROI) from your vacation rental without a good marketing strategy. After all, how can you receive bookings when people do not hear about your property or cannot find it at all?
To market your vacation rental, you will need to create a listing on popular vacation rental websites, such as Airbnb and HomeAway. These sites receive millions of visitors every month, so it is essential to take advantage of this exposure.
In addition to creating listings on vacation rental websites, you should also list your property on Google My Business (GMB). This will help ensure that your property comes up when people search for vacation rentals in your area.
Another marketing tactic that you can use is social media advertising. You can create ads on Facebook and Instagram that target people who are interested in traveling to your area. Just make sure to use high-quality photos and an enticing description to get people to click on your ad.
And, if you have a budget, you can create your own website for your vacation rental. This will give you more control over the design, content, and branding of your site. Plus, it will also allow you to collect leads through email marketing and online booking forms.
Purchasing a Vacation Rental Property: Important Factors to Look Into
Now that you know the basic requirements for a vacation home investment to rent out, it is time to look for your first property. Here is a factor checklist that you can use.
- Cap Rate
- Condition of the Property
- Local Rental Laws and Regulations
The location of the house is probably the most important factor to consider when learning how to buy a rental property. You want to make sure that it is in a desirable area that will attract travelers.
Here are some things to keep in mind when choosing a location for your vacation rental.
- Is it close to popular tourist attractions?
- Is it near public transportation?
- What is the crime rate in the area?
- What is the neighborhood like?
- What are the surrounding businesses and amenities?
Keep in mind, however, that locations with high demand tend to come with a higher price tag. So, you may have to sacrifice some things on your list in order to stay within your budget.
The capitalization rate (cap rate) is a measure of the expected ROI from a rental property. In other words, it tells you how much income you can expect to generate from the vacation home you are buying after accounting for all expenses.
To calculate it, you can divide the net operating income (NOI) by the property’s purchase price.
Cap Rate = NOI / Purchase Price
The higher the cap rate, the better ROI you can expect from the property.
For example, let’s say that you are considering two properties with identical NOIs of $30,000. However, Property A is priced at $300,000 while Property B is priced at $400,000. This means that Property A has a cap rate of .10 or 10%, while Property B has a cap of .075 or 7.5%.
For starters, it would be best for you to find a property with a cap rate that ranges from 8% to 10%. This would give you a healthy and stable stream of rental income and ensures you have enough money to pay off your mortgage and other expenses.
So, based on the example above, it is clear that Property A is the better investment.
Condition of the Property
As an investor, you would want to find a vacation rental property that is in good condition. Not only will this make it easier to attract guests, but it will also help you keep your maintenance costs low.
So, when viewing a potential property, try to see if it has a well-maintained exterior with no visible damage, a clean and updated interior, functional appliances and fixtures, as well as adequate lighting.
Apart from these, you could also find a property with the amenities and creature comforts that travelers would love to have during their stay. For example, you can find one with a private pool, a hot tub, or a game room. These things would make it easier for you to attract guests and charge a higher rental rate.
Of course, you can always buy a fixer-upper and renovate it to meet your standards. You can factor in the repairs when negotiating the final price with the seller. Just keep in mind, however, that this will take more time and money than buying a property that is already in good condition.
Local Rental Laws and Regulations
When purchasing a vacation rental property, it is important to be aware of the local laws and regulations regarding short-term rentals. You would not want to purchase a property only to find out later that you are not allowed to rent it out for short periods of time.
So, before making an offer on a property, make sure to do your research and find out about the following.
- Zoning regulations in the area
- Minimum rental period required
- Occupancy limits set by the city or homeowners association
- Permits or licenses required for operation
- Noise ordinances in place
All of these things will have an impact on your business, so it is important to be aware of them before making a purchase.
How to Own a Vacation Rental Property
As for how to own a vacation rental property, there are two ways that you can do it: manage the property on your own or hire a vacation rental management company.
If you decide to manage the property on your own, then you will be responsible for all aspects of the business. These include marketing your property, handling bookings and reservations, cleaning and maintaining the property, as well as dealing with any issues that may arise. Of course, this will take up a lot of your time and energy. Nonetheless, it will save you from the expenses of hiring another person to do all the legwork for you.
However, if you are not prepared to put in the work, then it is best to hire a vacation rental manager. This company will handle all of the aforementioned tasks for you. They will also be able to provide additional services, such as marketing and advertising, which would help you fill up your vacancy rate. While there is a fee associated with hiring a vacation rental management company, it is often worth it for the peace of mind and free time that you will get in return.
Whether you proceed with your business on your own or hire a manager to handle your property, it is important to remember that there are pros and cons to each approach. In the end, it is up to you to decide which one is best for your situation.
The Bottom Line
Without a doubt, when you learn how to buy a rental property the process becomes easier. After all, most people want to build wealth and attain financial freedom. However, it is not something that should be made lightly. There are many things to consider to ensure your business will be a success. But if you do your homework and make smart decisions, then owning a vacation rental property can be a very rewarding experience.
For more of the latest news, tips, and information on real estate, feel free to check out the other articles on our site. Happy investing and good luck!